Willingness to Pay for Weather Derivatives by Australian Wheat Farmers

A theoretical optimal hedging model is developed to determine potential demand from Australian farmers for a hedging tool to remove the economic consequences of climate related variability in wheat yield. In the past, financial instruments have been developed to hedge price risk on capital markets; however, in more recent times new financial instruments, weather derivatives, have been developing that hedge the volumetric risk associated with unfavourable weather. Weather derivatives have the ability to effectively hedge weather related volume risk for the agricultural, mining, energy and manufacturing industries, while also providing a risk management tool for construction firms and special events organisers, although there are still many hurdles to implementing agricultural weather derivative contracts in Australia. The optimal hedging ratio is found to be quite sensitive to the degree of risk aversion of the farmer and to the cost of obtaining the contracts.