Livestock Risk Protection Basis Risk for Feeder Cattle

Abstract

Recent government subsidies make livestock risk protection (LRP) insurance an affordable price risk management tool for many U.S. cattle producers. LRP insurance triggers a loss when the Chicago Mercantile Exchange (CME) Feeder Cattle Index falls below the selected coverage price. The CME Feeder Cattle Index is a 7-day weighted average of feeder cattle prices in 12 states. This paper determines if LRP policy holders who produce feeder cattle in states whose feeder cattle prices are not included in the CME Feeder Cattle Index are exposed to excess basis risk. To do this, we use a hedonic regression model to determine how state, year, month, and cattle types contribute to expected feeder cattle basis. We also consider asymmetric differences in LRP basis risk by separately modeling upside and downside risk. We find that Southeast cattle producers and producers marketing cattle in the fall face more LRP basis risk. The results have important implications for risk management tools for small cattle producers in the Southeastern United States, who have traditionally lacked access to livestock price risk tools such as futures and options