Climate derivatives strategies as an alternative to set up guaranteed prices for agricultural producers in México

ABSTRACT

This article proposes climate derivative strategies as an alternative to set up guaranteed prices for agricultural producers with the idea that this market mechanism replaces direct government intervention and traditional insurance. To do that, we apply a bivariate time-varying copula to model temperature behaviour as a shadow price of each degree Celsius above or below a given temperature band. We apply the methodology to a wheat-producing region of Apan Hidalgo in México, where the temperatures may vary from −8 to 33°C in a 7-year sample. The proposed time-varying copula uses the minimum and maximum temperature as risk factors in a normal copula with logistic marginals. This copula acceptably fits the original data with a slight delay to the seasonal regime change, but on average, it acceptably mimics the extreme temperature behaviour. The design of the derivative strategies (long American-Parisian-instalment strangles) with underlying temperatures is carried out through a Monte Carlo simulation valuation. Our proposal is more cost efficient than the current programme, a guaranteed price system, broadening its scope and benefiting more farmers.

KEYWORDS:

• Climate derivatives
• guaranteed prices
• time-varying copula
• exotic option

JEL CLASSIFICATION:

• G32
• Q54
• C63.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ 72% of the agricultural land does not possess any irrigation or technification system (Servicio de Información Agroalimentaria y Pesquera, Gobierno de México 2017).

² See Ortmann and King (2007a), Valentinov (2007) and Ortmann and King (2007b) to get a more in-depth insight into this issue.

³ See Centro de Estudios para el Desarrollo Rural Sustentable y la Soberanía Alimentaria (CEDRSSA) (2018).

⁴ See Secretaría de Hacienda y Crédito and Federal (2018).

⁵ SEGALMEX is attached to the Mexican Agriculture Ministry, SAGARPA.

⁶ For details see Lustig and Pérez Espejo (1982) and Rodríguez Chaurnet (1980).

⁷ CONASUPO (Compañía Nacional de Subsistencia popular or National Company of Popular Subsistence), extinguished on 1999 in the middle of a scandal of alleged corruption, was the government agency responsible for the subsidized food distribution.

⁸ See Swinnen (2007) and Randrianarisoa and Minten (2001).

⁹ Not only the poorest, whose premiums may be covered by the government and/ or wholesale traded.

¹⁰ The interested reader on tailoring specific weather risk derivatives may see Turvey (2001), Pirrong and Jermakyan (2008) and Li (2018).

¹¹ Other investigations that contrast weather insurance with weather derivatives can be found in Ender and Zhang (2015) in China and Ray (2016) in India.

¹² Authors as Manner and Reznikova (2012), Aloui et al., (2013) and Oh and Patton (2018) used the time-varying copula in a more traditional financial environment.

¹³ Other types of copula are found in Genius and Strazzera (2008) and Venegas-Martínez (2008).

¹⁴ The original paper is in French. We refer to Nelsen (1998).

¹⁵ Some agriculture techniques suggest that a mix of crops is the best choice to conserve the land.

¹⁶ The data set is available under request.

¹⁷ Agencia de Servicios a la Comercialización y Desarrollo de Mercados Agropecuarios in Spanish. https://www.gob.mx/aserca