Efficiency of agricultural commodity futures market: a project report

Abstract

The project examines the efficiency of the agricultural commodity futures market in India and USA. This provides insight into markets which are at two extreme corners of the development spectrum Indian market is fast developing and USA market is well established. In India Government intervenes by trying to maintain buffer stocks, they try to fix prices, they have import-export restrictions and a host of other interventions to smoothen price fluctuations. Liberalization of the markets has resulted in risk management instruments like futures. An efficient agricultural commodity futures market helps farmers through price discovery before harvest, to hedge against adverse price fluctuations or even for deciding the cropping pattern. A failure of UIP indicates that speculation may be profitable. For forward market to be efficient uncovered interest parity (UIP) condition should hold good. UIP postulates that market forces will drive future rate to equality with future spot rates. We examined the future and spot prices for wheat, channa and Soybean for India and wheat, Corn and soybean for USA for a period of two years from Jan, 2005 to Dec, 2007. These commodities are widely traded in National commodities and Derivatives Exchange limited (NCDEX) in India and Chicago Board of Trade (CBOT) in USA. We used a sum of least squares regression model. We felt that the market efficiency might vary for different time horizon. We analyzed the data for 3time horizons viz 1 month (small), 3 months (medium) and more than 3 months (long) to the date of maturity. We extended our study to analyze the impact of trading volume on the forward errorSome key findings of our analysis is as follows_ UIP fails in USA for long time horizons_ UIP holds well in USA for few commodities (soybean and corn) in small and medium time horizons._ A detailed analysis for wider basket of agricultural commodities is required to estimate the efficiency of the US market as a whole_ UIP fails in India for all time horizons. However we find that UIP holds good for few commodities (Channa, soybean) when future is trading at a premium to spot. We notice that Channa and Soybean futures trade at premium for more than 75% of the days. We reiterate that market is not efficient._ In the Indian market, the forward error is not explained by the trading volumes. There is poor correlation between the forward error and the trading volume.