Developing and Pricing Precipitation Insurance

Production agriculture and agribusiness are exposed to many weather-related risks. Recent years have seen the emergence of an increased interest in weather-based derivatives as mechanisms for sharing risks due to weather phenomena. In this study, a unique precipitation derivative is proposed that allows the purchaser to specify the parameters of the indemnity function. Pricing methods are presented in the context of a cotton harvest example from Mississippi. Our findings show a potential for weather derivatives to serve niche markets within U.S. agriculture.