Willingness to Pay for Weather Derivatives by Australian Wheat Farmers

A theoretical optimal hedging model is developed to determine potential demand from Australianfarmers for a hedging tool to remove the economic consequences of climate related variability inwheat yield. In the past, financial instruments have been developed to hedge price risk on capitalmarkets; however, in more recent times new financial instruments, weather derivatives, have beendeveloping that hedge the volumetric risk associated with unfavourable weather. Weatherderivatives 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 forconstruction firms and special events organisers, although there are still many hurdles toimplementing agricultural weather derivative contracts in Australia. The optimal hedging ratio isfound to be quite sensitive to the degree of risk aversion of the farmer and to the cost of obtainingthe contracts.