Hedging with weather derivatives to cope with climate variability and change in grain maize production

The effectiveness of hedging drought risks with weather derivatives was investigated for rain-fed grain maize production in Switzerland under current (1981-2003) and projected future (2070-2100) climatic conditions. Depending on location, hedging reduced the value-at- (VaR) measure to a variable degree, although with a considerable basis risk, but hedging may provide a valid risk transfer since loading of 90 per cent to 240 per cent of the fair premium can be paid to obtain a hedged situation with improved outcomes relative to the reference. However, the fair premium of a specific contract may vary by a factor of two to four over the 70-year period considered, which represents a substantial uncertainty for both the farmer and the institution writing the contract.