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Agriculture production yield varies with weather changes. This causes farmers incur loses. For instance, extreme temperature leads to low maize yield. This study describes incomplete temperature weather derivatives in agriculture markets and applies risk management hedging techniques. It focuses on hedging crop yield against extreme temperatures during irrigation, farming which is done without greenhouse. This study's primary goal is to hedge irrigated maize crop yields using temperature derivatives. This is achieved firstly by modelling a daily average temperature stochastical model. Then, deriving statistical properties of the model based on 1990–2020 Kasungu District Temperature historical data. Lastly, pricing temperature derivatives to hedge maize crop yield. This study uses 1990–2020 Kasungu District Temperature historical data. Then a stochastically Ornstein-Uhlenbeck process with the time-varying speed of reversion, seasonal mean, and local volatility that depends on the local average temperature was proposed. Based on the average temperature model, down and output barrier option pricing models for average temperature and growing degree day (GDD) are applied. The study results shows that when the GDD is above the barrier level the barrier option does not knock out. Hence gives the holder the right to buy the underlying asset since it does not reach or fall below a predefined level over the option's lifetime. If the GDD does not exceed the barrier level, then the farmer will not have to pay the premium because the option is invalid. On the same note, the farmer will have to exercise his right by paying the premium of calculated premium when the GDD exceeds the barrier level. In return for this, the farmer gets paid off which happens to be the difference between GDD and barrier multiplied $1. In line with Malawi's 2063 Millennium Development Goals (MDGs), this study acts as an eye opener for the government to put a policy on whether derivatives should be practised in our country hence, increase cash holding by improving the situation of the farmer and country. |
