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Weather Index Insurance and the Pricing of Spatial Basis Risk

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There have been some rigorous attempts to provide meaningful methods to quantify risk for weather index insurance in a spatial dimension. Part of the complication is that weather index insurance (or weather derivatives) pricing according to burn rate analysis deals not only with a spatial dimension but also a temporal one as historical frequencies are calculated. These calculations are further subjected to potential long-term trends due to climate change, as well as variations due to prevailing weather conditions according to the ENSO (El Nino Southern Oscillation) index. From an empirical point of view this paper investigates basis risk using a novel approach to space measurement.

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