Weather risk hedging mechanism for contract farming supply chain with weather-dependent yield

Abstract

The stability of contract farming is challenged by the impact of disastrous weather on crop yield. Managing weather risks has become an unavoidable reality for participants in contract farming. In this regard, this paper focuses on investigating weather risk hedging mechanisms for contract farming supply chain in a Newsvendor setting. As a benchmark, we first consider the agricultural production investment decision under the inherent mechanism (i.e. protective price mechanism) of contract farming. Due to the inevitable reduction of farmers’ agricultural investment levels and performance loss caused by disastrous weather under this mechanism, we then systematically propose innovative weather risk hedging mechanisms based on the completeness of both internal risk–benefit sharing mechanism of contract farming in developing economies and its external financial derivatives market. We define them as the operational weather risk hedging (OWRH), financial weather risk hedging (FWRH), and combined weather risk hedging (CWRH) mechanisms, respectively. The research findings are as follows: (1) The OWRH mechanism overcomes the distortion of agricultural investment levels and fosters a community of shared risks and benefits among contract farming participants, to reach the equilibrium with higher profits. Nevertheless, it falls short of externalizing weather risks. (2) The FWRH mechanism transfers disastrous weather risks encountered by contract farming and reverses the trend of decreasing performance as the disastrous weather intensify, yet it fails to resolve the distortion of agricultural investment levels and the internal distribution of profits among stakeholders. (3) The CWRH mechanism mitigates the distortion of investment levels and the decline of contract farming’s performance caused by intensifying weather disaster, improving the anti-risk capacity of contact farming. But it does not always contribute to the optimal profits for contract farming participants, instead, this achievement is only attainable in the face of severe weather. Meanwhile, it imposes higher requirements on the financial environment in developing economies. Furthermore, we provide distinct applicability boundaries for these weather risk hedging mechanisms. The aim is to provide valuable insights into the management of disastrous weather risks faced during the production process of contract farming supply chain in various regions of developing economies.