Hedging Late Frost Risk in Viticulture with exotic options

ELSA CORTINA; IGNACIO SÁNCHEZ

Agricultural Finance Review

Emerald

Año: 2012 vol. 73

0002-1466

AbstractPurpose: To model and to value a temperature derivative to hedge late frostrisk in viticulture.Design/methodology: Starting from 11 years of historical temperature datacollected in Mendoza, Argentina, we reconstruct the missing data using PrincipalComponent Analysis. The frequency content of time series is examinedby the periodogram method; ordinary least squares are used to estimate thetrends of minimum, maximum and average temperatures, and hypothesis testsof univariate and bivariate normality are performed on deseasonalized and filteredtemperature returns. We express the temperature dynamics by correlatedOrnstein-Uhlenbeck processes and historical data were fitted into the model toobtain parameters estimates. An Asian-type option on a temperature index isconstructed and its price and sensivities are computed by Monte Carlo method.Findings: We define an index in terms of minimum and average temperaturesthat, under some simplifying hypotheses, quantifies the damage produced by alate frost. To hedge the late frost risk an Asian-type option on the index is constructed.Together with the results concerning the design and pricing of the option,the analysis of historical data reveals non negligible linear trends, negativein minimum temperature and positive in maximum and average temperatures.These findings may be consistent with the hypothesis of global warming or withthe presence of out-of-phase very low frequency components.Originality: We have not found in the literature a similar option to hedge therisk of spring frosts faced by fruit producers.