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SPATIAL DEPENDENCE AND AGGREGATION IN WEATHER RISK HEDGING: A LÉVY SUBORDINATED HIERARCHICAL ARCHIMEDEAN COPULAS (LSHAC) APPROACH

Published online by Cambridge University Press:  26 April 2018

Wenjun Zhu ,
Ken Seng Tan ,
Lysa Porth  and
Chou-Wen Wang
Wenjun Zhu*
Affiliation:
Nanyang Business School, Division of Banking & Finance, 50 Nanyang Avenue, 639798, Singapore
Ken Seng Tan
Affiliation:
Department of Statistics and Actuarial Science, University of Waterloo, 200 University Ave. West, Waterloo, Ontario, Canada, E-Mail: [email protected]
Lysa Porth
Affiliation:
Warren Centre for Actuarial Studies and Research, University of Manitoba Asper School of Business, Winnipeg, Manitoba, Canada, E-Mail: [email protected]
Chou-Wen Wang
Affiliation:
Department of Finance, National Sun Yat-sen University, Kaohsiung, Taiwan, E-Mail: [email protected]
*
E-Mail: [email protected]
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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 Lévy subordinated hierarchical Archimedean copula model in modelling the spatial dependence of weather risk to reduce basis risk. The analysis shows that the Lévy subordinated hierarchical Archimedean copula model can improve the hedging performance through more accurate modelling of the dependence structure of weather risks and is more efficient 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 riskhedging strategieshierarchical Archimedean copulasLévy subordinatorsagricultural insurancereinsuranceC13C15C16G17G22Q19Q14
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 48 , Issue 2 , May 2018 , pp. 779 - 815
Copyright
Copyright © Astin Bulletin 2018 

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