Drought insurance in wheat and corn production with weather derivatives: the case of Serbia

Abstract

In the past, farmers have bought traditional insurance to protect them-selves against crop losses caused by weather. As a new tool, weather derivatives have the potential to support farmers against weather induced risks more efficiently than traditional insurance. Nevertheless the market for weather derivatives is still relatively limited. The objective of this analysis is to quantify the risk reducing effect that can be achieved by using weather derivatives in crop production. For this reason a crop farm in Serbia served as an example to determine the risk reducing effect in wheat and corn production, as they are the most important crops in Serbia with grate export potential. The paper applies stochastic simulation and value-at-risk methods. In the paper are presented fair premiums and payoffs of put options in wheat and corn production, as well as revenue distributions with and without weather derivatives. It was found that the risk reduction was more significant in wheat production (21.88%) than in corn production (18.13%). Therefore, in case of Serbia weather derivatives would be more useful in wheat production.