A study of basis risk in the use of weather derivatives for hedging of agricultural yield

摘要

Weather derivatives are a newer form of hedging the weather-related agricultural yield risk. The paper discusses the issue of geographic basis risk, which is likely to be an important factor when weather derivative trading is introduced in India. Withthe large number of villages and the large geographic spread, an understanding of the implications of basis risk would help, not only in the acceptability of weather derivatives as viable hedging instruments, but also in relevant policy matters. This would be so especially with respect to the number and kind of weather recording stations which would be required. The paper brings out a study of past data from two weather stations in New Delhi, located just a few kilometers apart, on rainfall correlations and uses these to indicate risks involved in using proxy weather stations.