Weather derivatives as a risk management tool for maize farmers in South Africa

Abstract

The study investigates the potential of weather derivatives to mitigate agricultural risk factors. Specifically, it examines the feasibility of rainfall options as a risk management tool in hedging yield risk for maize farmers in the North-Western Free State province of South Africa. The correlation between rainfall and crop yield is established by examining data on maize yield over a 20-year period. Results indicate that rainfall during January and February has the most significant impact on maize production. By using a Yield-at-Risk analysis, the study determines that a minimum rainfall level of 135mm during January and February is needed to ensure a good crop. The results show that rainfall options can be financially viable in South Africa, particularly in the water table region of the North-Western Free State. Although the study admits that farming profitability may not significantly improve, it shows that downside risk can be limited while still achieving a 30% profit on input costs, as offered by the region.