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Abstract

The increased interest in weather-based risk management tools in developed and developing nations gives rise to examining a new set of risk-contingent structured financial products. This paper examines a variety of models applicable to agriculture and the sovereign debt of developing agrarian nations including from the corporate side, weather-linked bonds, and from the producer side weather-linked loans and weather linked mortgages. These weather risk management tools are targeted towards mitigating both business and financial risk by reducing the contractual obligation of debt (principal and/or interest) depending on the intrinsic value of an attached weather option (e.g. excess heat or precipitation) which pays off if a specific weather event occurs. The paper also discusses the structure of a famine bond, which provides funds in advance of a high probability famine event brought about by a specific weather event such as drought. The models presented have broad application to agricultural economies that suffer from weather induced volumetric (production) risk.

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