Designing rainfall index based futures contracts: analysis of basis risk
by N. Dileep; G. Kotreshwar
International Journal of Financial Markets and Derivatives (IJFMD), Vol. 9, No. 3, 2023

Abstract: The basis risk is the difference between rainfall recorded in meteorological subdivisions (MSD) and rainfall recorded in rain gauge stations. Basis risk is an inherent problem in rainfall index-based derivatives contracts, because the payout in rainfall index-based derivatives depends on the strike and actual rainfall recorded at the locations where parties entered into the contract. As a result, the proposed study seeks to ascertain whether a basis risk exists in the South Interior Karnataka Meteorological Subdivision (SIK MSD). The study used monthly monsoon rainfall data for the years 2013-2020. The statistical tools like mean, standard deviation, coefficient of variation, and correlation analysis show that there is a basis risk in SIK MSD. The result of the hypothesis testing with the t test proved that there is a basis risk in SIK MSD for the study period. Therefore, the study designed city-based rainfall index-based futures (RIBF) contracts for the farming community and MSD-based RIBF contracts for those who are willing to take the contracts on a pan-India basis.

Online publication date: Fri, 15-Sep-2023

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