Development of weather derivatives: evidence from the Brazilian soybean market

The purpose of this study is to design a weather derivative contract and evaluate the hedging efficiency into the Brazilian soybean market against lack of rainfall in the crop cycle. We adopt European put options with two different types of underlying rainfall index (equal-weighted index and growth-weighted index), using a dataset of daily precipitation and annual production for six areas located in the south of Brazil. Pricing follows the index modeling method, using the estimated payoff distribution for fair premium calculation. The contract premium varied from 10% to 15% of revenue per hectare. Results show that the adoption of the weather-based derivatives reduced the producers' income volatility substantially (around 30%). Keywords: weather derivative, rainfall derivative, weather risk, soybeans. JEL codes: G22, G32, Q02, Q14.