Can Markets Discipline Government Agencies? Evidence from the Weather Derivatives Market
Amiyatosh K. Purnanandam
University of Michigan, Stephen M. Ross School of Business
Georgia Institute of Technology - Scheller College of Business
July 22, 2014
We analyze the role of financial markets in shaping the incentives of government agencies using a unique empirical setting: the weather derivatives market. The Chicago Mercantile Exchange has introduced several temperature related derivative contracts on different U.S. cities in a staggered fashion since 1999. The payoffs of these contracts depend on the temperature levels at a specific weather station in the underlying city. We show that the introduction of these contracts improves the accuracy of temperature measurement by the dedicated weather station of the National Weather Services (NWS) in that city. We argue that temperature-based financial markets generate additional scrutiny of the temperature data measured by the NWS, which in turn motivates the agency to minimize measurement errors. Our results have broader implications: the visibility and scrutiny generated by financial markets can potentially improve the efficiency of government agencies even in the absence of explicit incentive contracts.
Number of Pages in PDF File: 61
Date posted: August 31, 2012 ; Last revised: July 27, 2014
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