Hedging rainfall risk: An illustrative analysis of rainfall index-based futures contracts

N. Dileep and G. Kotreshwar ()
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N. Dileep: PG Department of Commerce, MMK SDM Mahila Mahavidyalaya, Mysuru, Karnataka 570 004, India
G. Kotreshwar: Department of Studies in Commerce, University of Mysore, Mysuru, Karnataka 570 006, India

International Journal of Financial Engineering (IJFE), 2024, vol. 11, issue 01, 1-22

Abstract: Various studies have attempted to explore rainfall index (RI)-based derivatives as a tool to hedge rainfall risk. But no study delved into the issue to discuss the potential deployment of those tools for hedging rainfall risk on a model based on RI-based futures (RIBFs). An illustrative analysis of RIBFs contracts as hedging instruments has been undertaken in this study. The study is fundamentally based on empirical data. A brief account of the rainfall risk profile is presented to indicate the risk diversification opportunity. Besides, the results of an analysis of the correlation between the RI and the stock market index are projected to establish the RI as a unique asset class. The monsoon rainfall data for 50Â years, i.e., from 1971 to 2020 have been considered. The Sensex and Nifty stock market indices data covered a period of 30 years, from 1991 to 2020. The study used correlation, the GARCH (1,1) model, and ratio analysis to test the hypotheses. A hypothetical insurance company representing major stakeholders in need of rainfall risk hedging has been taken as an example for evaluating the utility of RIBFs contracts as hedging tools. The results reveal that the party buying RIBFs contracts can significantly reduce the loss of revenue due to adverse monsoon outcomes.

Keywords: Rainfall risk; excess rainfall days; deficit rainfall days; RIBFs contracts and hedging (search for similar items in EconPapers)
JEL-codes: G10 G13 G15 G23 G52 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1142/S2424786323500597

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