Subsidy expansions, pricing wedges, and derivative markets: Evidence from livestock risk protection

Abstract

Government insurance premiums can diverge from derivative prices, creating pricing wedges relevant for subsidy design and market segmentation. Using Livestock Risk Protection (LRP) endorsements matched to Chicago Mercantile Exchange (CME) put options from 2005 to 2024, we examine how federal subsidy expansions changed public livestock insurance prices relative to market‐based protection. The net wedge equals the matched put premium minus the producer‐paid LRP premium and implementation costs. Average wedges are near zero overall but shift from negative before the 2019–2020 subsidy expansion to positive after the 2020 tiered subsidy schedule. Gross LRP premiums generally remain above matched put premiums, and a pre‐expansion subsidy‐rate counterfactual reverses the post‐expansion wedges, showing that statutory subsidies drive the change. Out‐of‐sample predictions based solely on lagged information identify matched contracts with more favorable realized wedges.