Rain premium
Weather, being quite a whole-hearted practitioner of the adage, "the only constant is change" keeps us guessing with altered seasons, varying wind patterns and mood-swings in temperature. For a farmer who is growing corn, an unpredictable downpour of rain or an unforeseen and extreme change in temperature may completely annihilate that year's crop haul. Dr. Rogemar Mamon, a Mathematics & Statistics professor at Western University's department of Statistics and Actuarial Sciences, observes that, "what the farmer needs is crop insurance linked to weather-related risk to help tide over these unavoidable and unpredictable circumstances."
A mistimed rainstorm can ruin any hope of a profitable harvest. We are all familiar with home and car insurance. The cost and overall value of the contracts are determined based on the likelihood of particular disasters and accidents, among other risk factors. But what is the price of a contract for which the value depends on the level of rainfall or snow? And, how does one insure against the unpredictable vagaries of weather?
Dr.Mamon has been using mathematics and statistics in conjunction with time series data to model temperature dynamics, rainfall level, for example, so that one can put a price-tag on rain. This kind of modelling provides support for the weather-derivative business covering products in the exchange-traded and over-the-counter markets. While it is extremely difficult to, in his words, "mathematically capture the uncertainty inherent in temperature modelling", Dr.Mamon and his students are using powerful mathematical tools to capture the salient features of randomness, seasonality and weather dynamics to more accurately inform the world of finance and insurance.
This kind of mathematical modelling is akin to modelling and assessing other types of catastrophes like earthquakes, which can wreak havoc on power grid installations and railway lines; but having the right kind of insurance and coverage can potentially save power and railway companies from economically perilous consequences.
Take Alessio Giorgini, a visiting graduate student from Sapienza University of Rome, Italy, and one of only five graduate students at Sapienza University to win the prestigious ten-thousand Euro Torelli-Fiaccodori scholarship awarded by a private foundation, the Fondazione Roma Sapienza, who under the supervision of Dr.Mamon, recently finished a project in Financial Modelling.
"Based on temperature readings that had been collected around the Toronto Pearson Airport, I developed a mathematical model that could accurately describe future temperature movements in and around that area," clarifies Alessio.
He hopes that eventually the farmers and, in general, the agriculture sector working with catastrophe-focused insurance companies will use these tools to gain financial protection from the potentially harmful effects of weather by acquiring insurance tailored to their needs. "The world of weather modelling and its associated financial consequences is challenging and unpredictable," says Alessio. Currently working as a pricing analyst in Luxembourg, he looks forward to extending his research over the course of his career.
When traded on exchanges such as the Chicago Mercantile Exchange and transacted privately between two counter-parties, Dr.Mamon reckons that the collective notional value of all kinds of weather-dependent contracts could amount to hundreds of billions of dollars. Given the increasing and ever-prevalent repercussions of global warming and climate change, farmers will not be the only ones affected and weather insurance will be vital. For instance, Dr.Mamon pointed out that the Winter Olympics Committee could 'weather-insure' itself against the possible decrease in snowfall and governments of developing countries, through the various development banks, could plan ahead and set aside funds for possible drought insurance.
The pricing and risk management of weather derivatives as well as insurance contracts with option- or derivative-embedded features have certainly provided myriads of employment opportunities for graduate students in financial modelling and related fields. "While this field is relatively young, its applications are numerous," points out Dr.Mamon, and he adds that they offer a chance for a synergy of efforts involving researchers coming from various disciplines such as the mathematical sciences, earth sciences and meteorology. This kind of mathematical modelling is akin to modelling and assessing other types of catastrophes like earthquakes, which can wreak havoc on power grid installations and railway lines; but having the right kind of insurance and coverage can potentially save power and railway companies from economically perilous consequences.
Throughout the ages, weather has been revealed to us in various ways. Writers converse about it through words; painters interpret its vagaries through a spectrum of colour and texture, while musicians convey its undertones with woodwinds and strings. Dr.Rogemar Mamon trains his students to become mathematical artisans, capable of extricating patterns and structures from stochasticity and complexity, and then conveying nature's beauty in the language of mathematics and statistics. Alessio considers Dr.Mamon the master artist. “I was just lucky to have an opportunity to spend some time in his studio,” he says.