Analysis of legal and economic aspects of precipitation weather derivatives for Serbian agricultural sector

Abstract

Weather derivatives are not present in Serbia nor in the neighbouring countries and have no significant application in the European Union, either. Weather derivatives originated in the USA, where the market for these instruments is most developed, in terms of both economy and law. However, positive effects of their application, through the decrease of influence of unfavourable weather conditions on agricultural crops, are a good basis for their further study. The most common reasons for their absence from our financial market are their complexity and the inexistence of prerequisites for their introduction. This paper analyses legal and economic aspects of weather derivatives, as forms of financial derivatives, as well as weather derivative contracts concluded with the aim of hedging against precipitation exposure. The goal of the analysis is to find an optimal contract structure, but also the conditions that have to be met in order for its signing to be economically justified for both contractual parties, as well as the creation of preconditions for this weather derivative contract to be the instrument of trade on the financial market. The paper also analyses normative frameworks for the conclusion of these derivative contracts, as well as the necessity to educate market participants, which refers both to agricultural producers and financial institutions. Furthermore, it emphasizes the difference in relation to the classical contract of insurance against drought risk.

Keywords

• hedging strategies
• precipitation quantity
• weather derivatives