Market-based methods for monetizing uncertainty reduction
- 32 Downloads
New measurement systems are often expensive and need a solid economic justification. Traditional tools based on the value of information are sometimes difficult to apply. When risks are traded in a market, it may be possible to use market instruments to monetize the reductions in uncertainty. This paper illustrates such market-based methods with a satellite system designed to reduce uncertainty in predicting soil moisture in the USA. Soil moisture is a key variable in managing agricultural production and predicting crop yields. Using data on corn and soybean futures, we find that a 30% reduction in the weather-related component of uncertainty in corn and soybean futures pricing yields a yearly US consumer surplus of $1.44 billion. The total present value of information from the satellite system for the USA—calculated with a 3% discount rate—is about $22 billion, assuming the system is in operation for 20 years. The global value of the improvements in weather forecasting could be $63 billion.
KeywordsValue of information Options pricing SMAP Bachelier formula Black–Scholes-Merton model
JEL ClassificationC02 C44 C58 D80 D81
This research was supported through NASA cooperative agreement number NNX17AD26A with RFF to estimate the value of information obtained from satellite-based remote sensing. Helpful conversations with Vanessa Escobar and Paula Bontempi are gratefully acknowledged.
- Haug EG (2007) The complete guide to option pricing formulas, vol 2. McGraw-Hill, New YorkGoogle Scholar
- Lawrence DB (2012) The economic value of information. Springer, New YorkGoogle Scholar
- Pianca P (2005) Simple formulas to option pricing and hedging in the Black-Scholes model. Rend Studi Econ Quant 1:223–231Google Scholar
- Rouah FD, Vainberg G (2007) Option pricing models and volatility using Excel-VBA, vol 361. Wiley, New YorkGoogle Scholar
- Weatherhead E, Wielicki BA, Ramaswamy V, Abbott M, Ackerman T, Atlas B, Brasseur G, Bruhwiler L, Busalacchi T, Butler J, Clack CTM, Cooke R, Cucurull L, Davis S, English JM, Fahey D, Fine SS, Lazo JK, Liang S, Loeb N, Rignot E, Soden B, Stanitski D, Stephens G, Tapley B, Thompson AM, Trenberth K, Wuebbles D (2018) Designing the climate observing system of the future. Earth's Future. https://doi.org/10.1002/2017EF000627 CrossRefGoogle Scholar
- Westcott PC, Jewison M (2013) Weather effects on expected corn and soybean yields. USDA Economic Research Service, Washington, DCGoogle Scholar