Assessing Basis Risk in Margin Insurance for Beef Cattle Farming in Brazil

ABSTRACT Price volatility in agricultural markets directly affects the financial viability of rural producers, particularly in sectors characterized by narrow profit margins and long production cycles, such as beef cattle production. Futures contracts and agricultural insurance are commonly used to mitigate this risk; however, both instruments are exposed to basis risk, which arises from the divergences between futures and spot prices. This article has two objectives: to estimate the basis risk of futures contracts for fed cattle, feeder cattle, and corn, and to assess the basis risk associated with designing a gross margin insurance product adapted to the Brazilian context. The results show that basis risk for fed cattle and corn contracts was lower in São Paulo (7.51% and 4.85%, respectively) than in Mato Grosso do Sul (11.34% and 5.79%). Using state‐level prices as a proxy for feeder cattle futures reduced basis risk in both states, although the São Paulo proxy exhibited higher relative basis risk. The basis risk of the gross margin insurance product was estimated at 31.23% in São Paulo and 32.39% in Mato Grosso do Sul. These findings indicate that incorporating regional price differentials into margin insurance valuation is an effective policy strategy to reduce basis risk, allowing insured margins to better reflect local market conditions without introducing new futures contracts.