Monsoon has been, and continues to be, one of the major sources of risk impacting the Indian economy, especially in agriculture. Food security for the nation must be accompanied by financial security for the producers of food. The traditional crop insurance program has proved very expensive and involves classical problems of moral hazard and adverse selection. Indexbased insurance is found to be a viable alternative to traditional crop insurance. To realize its full potential, however, requires effective convergence of insurance and financial markets via Special Purpose Vehicles (SPVs), including monsoon derivatives. The real challenge is to develop monsoon derivatives market that would help efficient management of monsoon risk. This paper aims at the conceptualization of monsoon derivatives by defining the underlying variable in terms of Millimeter Rainfall Days (MRDs). Further, the problem of pricing monsoon derivatives, based on the distribution approach underlying the acturial method by taking the data of a specific meteorological division for a period of 50 years (19542003), is analyzed. Examples of structures of some monsoon option contracts are also presented in the paper.
The south-west monsoon1 is the driving mechanism of weather patterns in the Asian region,
particularly India. An amberite nature of monsoon weather pattern is further aggravated by the
increasing incidence of El Nino.2 The drought of 1987, in terms of temperature and
precipitation anomalies, was one of the worst of the 20th century. The drought was attributed
to El Nino, which is statistically correlated with the type, location and timing of the usual
weather patterns (Krishnamurthy, 2001). The El Nino weekend, the south-west monsoon
circulation resulting in below-normal rainfall and high temperature damaged crops and stressed
livestock throughout the country.
The south-west monsoon governs the very pulse of life in India. The prospects of
agricultural sector, which accounts for 30% of India’s GDP and 67% of labor force, depend upon the normal monsoon. The highest concentration of non-irrigated agriculture occurs in western
and southern oilseed, grain and cotton areas and in the East, where much of the paddy is
rainfed. These crops would suffer most from the late or weak start to the monsoon season, and
could be considerably affected during an extended break in monsoon rains. Conversely, a
strong monsoon circulation can bring flooding.
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