Using weather derivatives to hedge the volumetric risk of wheat crops. An experimental study to hedge temperature fluctuations using daily degree options.

Abstract

Climate change has become one of the strongest speeches and talks in the world. The rise in temperatures, which is attributed to the rising levels of carbon dioxide, as well as the increased volatility in the levels of precipitation, is conducive and will lead to an increasingly diverse combination of negative climatic, economic, social and biological influences, and thus the impact of weather on activities Commercial activity appears huge and dangerous, and it varies according to the commercial activity, location, size and level of change in climatic variables. In the agricultural sector (the focus of this study), temperature fluctuations can occur on the volume of basic commodities produced at the country level, not to mention its consequential impact on the quality and quality of these commodities and thus their prices, not only locally but internationally. This huge risk burdened those who were exposed to it, whether individuals, institutions, or countries. It became necessary to search for a tool that would partially or fully contribute to tackling this problem, so weather derivatives were the suggested way to do so. The risks covered by weather derivatives include the potential adverse effect of weather on expected costs, revenues and cash flows.

 Weather derivatives are modern and wonderful innovative tools for the commodification of the weather, that is, to transform the variables of weather balances into a commodity that can be traded in the markets and between dealers, buying and selling. It constitutes the pinnacle of creativity in contemporary financial engineering thought. Therefore, this study attempts to propose and choose the most successful strategies that can be adopted to eliminate or reduce the impact of the volumetric risk of basic commodities. The idea of ​​this method is based on the idea of ​​reducing weather risks that lead to a decrease in crop yields by preparing potential financial engineering according to accurate scientific mathematical rules and procedures, aimed at building trading strategies based on weather futures options, the main objective of which is to hedge the volumetric risk of the selected commodities (wheat) Generated due to fluctuations in the studied weather variables (temperatures).

For the purpose of achieving the objectives of this study, temperature data for the studied countries (Iraq and the United States) were collected for the period (2006-2020). By using a number of financial, mathematical and statistical methods, the study concluded with many conclusions, perhaps the most important of which is that it is possible to eliminate the potential effects of weather fluctuations in the volume of production of basic commodities by using weather futures options and that hedging through these tools is much better than not hedging at all. The study reached a number of recommendations, the most important of which is the need to resort to international weather derivatives markets, as a first step, in order to hedge the heart in Iraq’s needs of wheat and rice crops arising from weather fluctuations in Iraq and in the countries exporting these commodities, through cross-hedge strategies and the establishment of a market for weather derivatives in Iraq , as a second step after completing all the necessary and sufficient conditions to complete this because of its great importance in implementing the strategies for managing the weather risk faced by the various economic sectors in the country.