WEATHER DERIVATIVES: CONCEPT AND APPLICATION FOR THEIR USE IN SOUTH AFRICA

Recent innovations in energy markets suggest the possibility of addressing agricultural risk factors by issuing derivatives on weather elements. Such instruments appear particularly attractive, as asymmetric information and loss adjustment issues do not affect them. The paper first describes the concept, functioning and application of weather derivatives. It then examines the functioning and application of weather derivatives. It then examines the feasibility of rainfall derivatives to manage agricultural production risk in South Africa (SA) by evaluating the merits of rainfall options, and suggesting an option strategy, as a yield risk management tool. The use of rainfall derivatives in SA is likely to increase in future as capital markets, financial institutions, insurance companies, crop insurance companies and hedge funds collectively organize themselves to share and distribute weather risks.