Climate derivatives strategies as an alternative to set up guaranteed prices for agricultural producers in México

This article proposes climate derivative strategies as an alternative to set up guaranteed prices for agricultural producers with the idea that this market mechanism replaces direct government intervention and traditional insurance. To do that, we apply a bivariate time-varying copula to model temperature behaviour as a shadow price of each degree Celsius above or below a given temperature band. We apply the methodology to a wheat-producing region of Apan Hidalgo in México, where the temperatures may vary from −8 to 33°C in a 7-year sample. The proposed time-varying copula uses the minimum and maximum temperature as risk factors in a normal copula with logistic marginals. This copula acceptably fits the original data with a slight delay to the seasonal regime change, but on average, it acceptably mimics the extreme temperature behaviour. The design of the derivative strategies (long American-Parisian-instalment strangles) with underlying temperatures is carried out through a Monte Carlo simulation valuation. Our proposal is more cost efficient than the current programme, a guaranteed price system, broadening its scope and benefiting more farmers.