Basic characteristics of an index

tte underlying index used for index insurance products must be correlated with yield or revenue outcomes for farms across a large geographic area. In addition, the index must satisfy a number of additional properties affecting the degree of confidence or trust that market participants have that the index is believable, reliable, and void of human manipulation; that is, the measurement risk for the index must be low (Ruck 1999). A suitable index required that the random variable measured meet the following criteria:

• observable and easily measured;

• independentlyverifiable;

• reportable in a timely manner (Turvey 2002; Ramamurtie 1999); and

• stable and sustainable over time.

Publicly available measures of weather variables generally satisfy these properties.

For weather indexes, the units of measurement should convey meaningful information about the state of the weather variable during the contract period, and they are often shaped by the needs and conventions of market participants. Indexes are frequently cumulative measures of precipitation or temperature during a specified time. In some applications, average precipitation or temperature measures are used instead of cumulative measures. New innovations in technology, including sophisticated satellite imagery from which high resolution weather data may be extracted and low-cost weather monitoring stations that can be placed in many locations, will expand the number of areas in which weather variables can be measured as well as of the types of measurable variables. Measurement redundancy and automated instrument calibration further increase the credibility of an index.

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