Can Markets Discipline Government Agencies? Evidence from the Weather Derivatives Market

Abstract

We analyze the role of financial markets in shaping the incentives of government agencies using a unique empirical setting: the weather derivatives market. We show that the introduction of weather derivative contracts on the Chicago Mercantile Exchange (CME) improves the accuracy of temperature measurement by 13% to 20% at the underlying weather stations. We argue that temperature-based financial markets generate additional scrutiny of the temperature data measured by the National Weather Service, which motivates the agency to minimize measurement errors. Our results have broader implications: the visibility and scrutiny generated by financial markets can potentially improve the efficiency of government agencies.