Files
Abstract
Basis risk has been cited as a primary concern for implementing weather hedges. This study
investigates several dimensions of weather basis risk for the U.S. corn market at various
levels of aggregation. The results suggest that while the degree of geographic basis risk may
be significant in some instances, it should not preclude the use of geographic cross-hedging.
In addition, the degree to which geographic basis risk impedes effective hedging diminishes
as the level of spatial aggregation increases. In fact, geographic basis risk is actually negative
in the case most representative of a reinsurance hedge, and the reduction in risk from
employing straightforward temperature derivatives is significant. Finally, precipitation hedges
are found to introduce additional product basis risk. The findings may be of interest to
decision makers considering using exchange traded weather derivatives to hedge agricultural
production and insurance risk.