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KEYWORDS: Index based insurance, Monsoon Outcome Index, Rainfall index, Risk hedging
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I. INTRODUCTION
Financial markets can play a vital role in indemnifying the losses by means of risk sharing. Insurance market, being a conduit of financial markets, is solely lacking in India and is unable to address natural disasters like monsoon failure. There are several reasons why rural financial markets have not developed for risk-sharing from natural disasters that damage agriculture. First, some form of expoit failure (drought) relief is common in the form of free aid and debt forgiveness. As long as free aid or debt forgiveness is used, vulnerability to disasters becomes self-perpetuating. Second, the governments, both at the state and central level, operate highly subsidized public crop insurance programmes. Skees, et al (2001), Jennifer (2001), Spaulding, et al (2003) and Sinha (2004) found crop insurance programmes, in general, costlier than expected due to operational problems involved. Fortunately, developments in global financial markets provide unique opportunities for managing catastrophic risks. The two promising innovations that could provide for effective management of monsoon risk are: (1) Index-based insurance contracts and (2) Weather derivatives. Index-based insurance is an alternative form of insurance that makes payments based not on measures of farm yields, but rather on some objective weather event such as rainfall.
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Where Rit represents cumulative rainfall for end of ith month of the tth season; Rct stands for historical average cumulative monthly rainfall for the t th season; and 1000 is the multiplier value. The computation of MOX values for each of the major selected meteorological subdivision in place of few selected city/locations is preferable mainly for two reasons: The index becomes broad-based which in turn should facilitate the launch of a trading mechanism at the national level to meet the diverse needs, i.e., speculation, risk hedging and arbitraging. A broad-based index minimizes the impact of basis risk which looms large in any weather-based risk transfer product. According to equation (1), the MOX values have been computed for the selected 6 out of 36 meteorological subdivisions of India, summarized in Table 1(a,b). The selected meteorological subdivisions are Assam Meghalaya (ASMEG), Punjab (PUNJB), East Madhya Pradesh (EMPRA), Gujarat (GUJRT), Madhya Maharashtra (MADMH) and Tamilnadu and Pondicherry (TLNAD). They have been selected from North East, North West, West Central and Peninsular region. The graph of the MOX values for one of the sub division, Assam Meghalaya for all the monsoon months is provided in Fig 1(a,b).
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Year 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Year 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
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The rainfall data is sourced from the Indian Institute of Tropical Meteorology (IITM) website, for South-West monsoon season starting from 1st June and ending on 30th September and the MOX values for end of each month are computed for 30 years for the select 6 subdivisions. Rct, value is based on the 30 years moving average cumulative rainfall for the monsoon months. It can be observed that MOX value have taken a wide range both across years and subdivisions. For instance, the MOX value for the end of June month for Madhya Maharashtra (MADMH) sub division it varied between a minimum of 402 in the year 2009 and a maximum of 2158 in the year 1991.
Table: 2(b)Statistics of MOX Values for July for 30 Years rain fall data (1982-2011) Mean Std Deviation Coef. of Variation in % ASSMEG 918 166 18.12 PUNJB 961 409 42.51 EMPRA 1027 328 31.93 GUJRT 1053 345 32.72 MADMH 1029 268 26.08 TLNAD 1034 442 42.71
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Table: 2(d)Statistics of MOX Values for Sept for 30 Years rain fall data (1982-2011) ASSMEG Mean Std Deviation Coef. of Variation in % 951 155 16.29 PUNJB 927 310 33.42 EMPRA 989 176 17.83 GUJRT 1027 327 31.88 MADMH 1021 227 22.27 TLNAD 1032 323 31.27
Table: 2(e)Coefficient of Variation in % for all 6 sub for all 4 monsoon months ASSMEG JUN JULY AUG SEPT 21.07 18.12 17.20 16.29 PUNJB 67.81 42.51 28.88 33.42 EMPRA 56.54 31.93 19.49 17.83 GUJRT 82.43 32.72 28.15 31.88 MADMH 36.27 26.08 23.69 22.27 TLNAD 78.91 42.71 38.59 31.27
To determine the degree of inter-divisional independence in MOX values of rainfall data, correlation analysis amongst these 6 sample sub-divisions has been carried out Table 3(a,b,c,d). It can be seen that for very few subdivisions significant correlation exists and for majority of subdivisions the correlation is very weak and insignificant. This is amongst sample subdivisions and for all monsoon months. Geographically nearer subdivisions have moderate correlation where as distant sub-divisions have a correlation close to zero or in some cases even negative. Even within same sub division, MOX values for different monsoon months have variable correlation and will reduce as the months are apart. Such weak and insignificant correlation ideally creates portfolio situation for risk control on the basis of diversification principle.
Table 3(a): Correlation for June Month MOX values for 6 select sub-div ASSMEG ASSMEG PUNJB EMPRA GUJRT MADMH TLNAD 1.000 PUNJB -0.055 1.000 EMPRA -0.150 0.328 1.000 GUJRT -0.001 0.004 0.073 1.000 MADMH 0.031 0.136 0.093 .466** 1.000 TLNAD -0.083 0.310 -0.339 -0.098 .417* 1.000
Table 3(b): Correlation for July Month MOX values for 6 select sub-div ASSMEG ASSMEG PUNJB EMPRA GUJRT MADMH TLNAD 1.000 PUNJB 0.258 1.000 EMPRA -0.355 0.318 1.000 GUJRT 0.109 0.336 0.265 1.000 MADMH -0.084 0.070 0.237 .532** 1.000 TLNAD 0.126 -0.041 -0.242 0.142 .367* 1.000
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Table 3(d) : Correlation for Sept Month MOX values for 6 select sub-div ASSMEG ASSMEG PUNJB EMPRA GUJRT MADMH TLNAD **. Correlation is significant at the 0.01 level (2-tailed). *. Correlation is significant at the 0.05 level (2-tailed). 1.000 PUNJB 0.283 1.000 EMPRA -0.158 0.286 1.000 GUJRT -0.083 0.328 .418* 1.000 MADMH -0.033 0.142 0.057 .676** 1.000 TLNAD 0.261 0.037 -0.352 0.216 0.360 1.000
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In table 4, the equity indices, fixed income index and MOX values of select 6 subdivisions are considered for correlation coefficient calculations for index values as at the end of Sept month for the years 1997-2011(15 years). However, the Commodity Index DHAANYA is developed by NCDEX and is trading from 2007, so its correlation with other indices is for the years 2007 to 2011 (5 years) at the end of Sept month It can be seen from the table 4, the equity indices have weak correlation with bond index. The equity indices have insignificant correlation with MOX values and ranges from negative to positive. The bond index has insignificant correlation with MOX values and has weak correlation varying from positive to negative. The commodity index has strong significant negative correlation with ASSMEG and negative insignificant correlation with other subdivisions except EMPRA. MOX as an asset class complements other tradable indices as correlation of MOX values with other assets is insignificant and varying between negative to positive. For this reason the proposed MOX, if launched on an exchange, can be a potential tradable asset class. This means that those who seek to hedge risk will have a new instrument to their hedging arsenal. Options on MOX would be attractive for the hedgers and speculators as well.
VI. CONCLUSIONS
Rainfall index based RTPs are critical for the development of insurance and risk markets to create hedging opportunities to insurers and other players in the market whose financial prospects closely interconnected to monsoon outcome. In this background, conceptualization is attempted by constructing MOX series for select 6 meteorological subdivisions. The coefficient of variation analysis indicates existence of variations in the MOX values for rainfall amongst the sub-divisions and reverting of MOX back to the long time average rainfall at the end of monsoon period. It can be seen that for very few subdivisions significant correlation exists and for majority of subdivisions the correlation is very weak and insignificant. Geographically nearer sub-divisions have moderate correlation where as distant sub-divisions have weak to very weak (negative) correlation MOX as an asset class complements other tradable indices as correlation of MOX values with other assets is insignificant and varying between negative to positive.MOX can be an excellent instrument in the quest for portfolio diversification. For this reason the proposed MOX, if launched on an exchange can be a popular trading tool.
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