Temperature-based options for Vietnam: An option pricing and policy insight

The purpose of this paper is to test a temperature-based pricing model of Alaton (2002) in main rice-growing cities of Vietnam. The results of the test are then used for loss hedging analysis and policy implications for Vietnamese farmers, investors and related parties. Data are collected from General Statistics Office (GSO) of Vietnam, 2017 and Vietnam Meteorological and Hydrological Administration, with a reference to acuweather.com, on which the Alaton model is run. We suggest that temperature-based options are great tools for Vietnamese farmers to hedge unfavorable weather risks, and for investors to earn speculative profits. The great geographic diversity among Vietnam cities shows that there is a great potential to expand option contracts nationwide. By far, we acknowledge that findings are constrained by the limited temperature data in Vietnam, and the lack of comparable market prices. Furthermore, the pricing model itself assumes normal distribution, which might not fully capture the evolution of daily and seasonal temperature. Weather derivatives, especially the covered temperature-based options, are potential insurance for farmers and agricultural manufacturers besides existing price subsidiaries. From a policy perspective, the establishment of an active trading market can support the expanded use of weather derivatives within and outside the agriculture sector.   Key words: derivatives, mean-reversion process, agricultural finance.