Spatial Dependence & Aggregation in Weather Risk Hedging: A Lévy Subordinated Hierarchical Archimedean Copulas (LSHAC) Approach

Astin Bulletin, 48 (2), 779-815.

43 Pages Posted: 5 Oct 2015 Last revised: 25 Jan 2019

See all articles by Wenjun Zhu

Wenjun Zhu

Nanyang Business School, Nanyang Technological University

Ken Seng Tan

University of Waterloo

Lysa Porth

University of Manitoba - Warren Centre for Actuarial Studies and Research; University of Waterloo - Department of Statistics and Actuarial Science; University of Manitoba - Department of Agribusiness and Agricultural Economics

Chou‐Wen Wang

National Kaohsiung University of Science and Technology

Date Written: February 6, 2018

Abstract

Adverse weather related risk is a main source of crop production loss and a big concern for agricultural insurers and reinsurers. In response, weather risk hedging may be valuable, however, due to basis risk it has been largely unsuccessful to date. This research proposes the Levy subordinated hierarchical Archimedean copula (LSHAC) model in modelling the spatial dependence of weather risk to reduce basis risk. The analysis shows that the LSHAC model can improve the hedging performance through more accurate modelling of the dependence structure of weather risks and is more effcient in hedging extreme downside weather risk, compared to the benchmark copula models. Further, the results reveal that more effective hedging may be achieved as the spatial aggregation level increases. This research demonstrates that hedging weather risk is an important risk management method, and the approach outlined in this paper may be useful to insurers and reinsurers in the case of agriculture, as well as for other related risks in the property and casualty sector.

Keywords: Systemic weather risk, Hedging strategies, Hierarchical Archimedean copulas, Lévy subordinators

JEL Classification: C13, C15, C16, G17, G22, Q19, Q14

Suggested Citation

Zhu, Wenjun and Tan, Ken Seng and Porth, Lysa and Wang, Chou‐Wen, Spatial Dependence & Aggregation in Weather Risk Hedging: A Lévy Subordinated Hierarchical Archimedean Copulas (LSHAC) Approach (February 6, 2018). Astin Bulletin, 48 (2), 779-815., Available at SSRN: https://ssrn.com/abstract=2669114 or http://dx.doi.org/10.2139/ssrn.2669114

Wenjun Zhu (Contact Author)

Nanyang Business School, Nanyang Technological University ( email )

50 Nanyang Avenue
Singapore, 639798
Singapore
(65) 6592-1859 (Phone)

HOME PAGE: http://sites.google.com/view/wenjun-zhu

Ken Seng Tan

University of Waterloo ( email )

Waterloo, Ontario N2L 3G1
Canada

Lysa Porth

University of Manitoba - Warren Centre for Actuarial Studies and Research ( email )

638 Drake Centre, 181 Freedman Crescent
Winnipeg, MB R3T 2N2
Canada

University of Waterloo - Department of Statistics and Actuarial Science ( email )

Waterloo, Ontario N2L 3G1
Canada

University of Manitoba - Department of Agribusiness and Agricultural Economics ( email )

Winnipeg, MB, R3T 2N2
Canada

Chou‐Wen Wang

National Kaohsiung University of Science and Technology ( email )

2 Jhuoyue Rd.
Nanzih
Kaohsiung City, Taiwan 811
Taiwan

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