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The Feasibility of Rail Track Delivery as an Alternative Settlement Option for KCBT Wheat Futures Contracts
Daniel M. O’Brien and Jay O’Neil
Year: 2011
 

Abstract

Railcar or “track” delivery is an alternative delivery mechanism considered by the Kansas City Board of Trade in 2010 to help bring about cash-futures convergence. Track delivery would provide an alternative way to physically deliver wheat via railroad cars without relying on the issuance of warehouse receipts from delivery point elevators. This study shows that during the May 2010 through February 2011 period profitable opportunities to deliver wheat on KCBT futures existed from selected Kansas, Oklahoma and Nebraska grain elevator locations where basis was wider than rail transportation and grain elevator handling costs. Barriers to adoption of track delivery include timely, seasonal delivery of railcars from country locations to delivery locations in Kansas City and availability of railcar-weighing scales for determination of weights and measures at country elevator locations. The niche for railcar track delivery is that it could provide an extreme punitive outer bound for wheat basis levels, defining an outer limit on hard red winter wheat cash-futures price differentials.

 
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Grain Marketing Tools: A Survey of Illinois Grain Elevators
Ryan Stone, Colin Warner and Rick Whitacre
Year: 2011
 

Abstract

The basic services offered by country elevators are very similar (purchasing, conditioning and storing grain), country elevators attempt to differentiate themselves from their competition by offering customers a variety of cash grain marketing tools. These tools range from the basic cash forward contracts to minimum price contracts to the so called “new generation grain marketing contracts”. The purpose of this paper is to report the results of a 2010 survey of Illinois country grain elevator managers. The primary objective of the survey was to determine the marketing contracts grain elevator firms operating in Illinois offer their customers and the extent to which these contracts are used by the elevator’s customers.

 
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Hedging and Cash Flow Risk in Ethanol Refining
Roger A. Dahlgran, and Jingyu Liu
Year: 2011
 

Abstract

Interviews with ethanol refinery risk managers reveal that, at least for the firms represented, (a) working capital to fund margin accounts is limited so the optimal deployment of this capital is a major concern, and (b) these firms hedge with smaller positions than those indicated by the traditional price risk minimization theory. In response to those observations, this study examines the relationship between hedge outcome price risk and price risk induced intra hedge cash flow risk. A simulation analysis of a simple long hedge indicates that the sum of hedge outcome risk and intra hedge cash flow risk is minimized at hedging levels well below the levels that minimize only the hedge outcome risk. The model is generalized to apply to a commodity processor using ethanol refining as a specific example. While the preliminary results are promising, data deficiencies prevent pursuing the analysis to its logical completion. Steps for extending this study using higher quality data are proposed.

 
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Price Discovery in U.S. and Foreign Commodity Futures Markets: The Brazilian Soybean Example
Gerald Plato and Linwood Hoffman
Year: 2011
 

Abstract

Trader direct access to the order matching systems on United States and foreign commodity futures markets reduces or eliminates the cost of changing trading venues. The Dodd-Frank Act recognizes that price discovery could now more readily shift to foreign futures markets if futures market regulations in the United States were more stringent than those for foreign futures markets. Price discovery is the incorporation of market fundamentals into price. It is done by traders that make trades based on informed judgments about market fundamentals The Act does not provide guidance on how to measure price discovery. We examine the use of the Gonzalo- Granger Decomposition to measure the relative soybean price discovery contribution of the Chicago Mercantile Exchange and the Brazilian Mercantile and Futures Exchange. Daily opening and closing soybeans prices from the two exchanges are used in the examination. We provide evidence that there is exchange of soybean price fundamentals between the two exchanges after the beginning of direct trader access between the two exchanges. Simultaneous soybean transaction prices are required for making reliable estimates of the relative contribution of each futures exchange to soybean price discovery.

 
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The Informational Content of Distant-Delivery Futures Contracts
Kristin N. Schnake, Berna Karali, and Jeffrey H. Dorfman
Year: 2011
 

Abstract

The futures markets have two main goals: price discovery and risk management. Because management decisions often have to be made on a time horizon longer than the time until expiration of the nearby futures contract, the question of distant-delivery futures contracts’ ability to assist in price discovery is important. We focus on soybean and live cattle distantdelivery futures contracts and test for the informational value added to nearby contracts. Two tests for information value provide partially conflicting results due to the different information measures employed. If being able to predict the price trend is sufficient, then we find some information value in distant-delivery futures contracts, while if accurate point estimates of future spot prices are desired the results are negative. Surprisingly, we do not find the expected dichotomy between the storable (soybeans) and non-storable (cattle) commodities.

 
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Evaluation of Market Thinness for Hogs and Pork
Jason Franken and Joe Parcell
Year: 2011
 

Abstract

We investigate thinness of hog and pork markets in terms of quantity and representativeness of negotiated transactions. Transactional volume imparts marginally greater confidence in pricing precision for Iowa-Southern Minnesota negotiated hogs than for the national carcass cut-out, suggesting that contracts tying prices to the former rather than the latter may be more representative of industry conditions. Extending mandatory price reporting to pork may remedy this discrepancy. Despite declining volume, terminal hog markets may price accurately off of Iowa-Southern Minnesota prices. Hog quality differentials across procurement methods are documented, and quality of negotiated hogs is shown to decline with volume.

 
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Marketing Strategies in the Canadian Beef Sector
Julieta Frank, Derek Brewin, and María José Patiño
Year: 2011
 

Abstract

The Canadian beef sector has undergone a structural change since the outbreak of BSE in 2003 and a higher U.S./Canadian dollar exchange rate variability. Hedging beef prices and the U.S. dollar using the futures market may help producers and other beef market participants to alleviate some of their price risk. We assess the hedging usefulness of the CME Group futures contract in total price risk reduction for Canadian cattle market participants and we examine the implications of exchange rate variability on optimal commodity hedging. Futures hedging after BSE removes approximately 35% of the risk, and a combined commodity and currency hedge after BSE was discovered removes approximately 50% of the risk. Hedge ratios are in general low, approximately 0.29 when a combined cattle-currency hedge is performed.

 
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Changes in Liquidity,Cash Market Activity, and Futures Market Performance:Evidence from Live Cattle Market in Brazil
Fabio Mattos and Philip Garcia
Year: 2011
 

Abstract

This paper describes developments in the Brazilian live cattle market in the last decade, which resulted in an almost tenfold increase in futures trading, and investigates their effects on futures market’s price discovery and risk transfer functions. Higher trading volume appears to have modestly reinforced the long-run relationship between spot and futures markets, strengthened the role of futures market in the pricing process, and led to a more rapid transmission of market information between spot and futures markets. In terms of risk transfer, the results provide little evidence that the live cattle futures contract offers effective hedging opportunities, either under low or high trading volume. The findings are consistent with previous studies in the sense that even low trading volume is enough to establish links between spot and futures markets. However, the absence of hedging opportunities when futures trading increases was somewhat surprising and raises questions for future research.

 
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Elimination of the Coffee Export Quota System Revisited: Evaluating International-to- Retail Price Transmission
Jun Lee and Miguel I. Gómez
Year: 2011
 

Abstract

We revisit the impact of the International Coffee Agreement (ICA) on international-to-retail price transmission. We account for two distinct dimensions (e.g. symmetry vs. asymmetry and linearity vs. nonlinearity) of price transmission from international to retail coffee prices in France, Germany and the United States. We show that ignoring these two features of the price transmission process may lead to misleading impact assessments of the ICA elimination in 1990. Our results confirm the presence of threshold effects in price transmission in both periods (ICA and post-ICA) in the three countries. Our estimates show that, in the long-run, the speed of adjustment toward equilibrium becomes faster during the post-ICA period in France and Germany. Our results suggest that, for France and Germany, changes in international prices did not influence retail prices in the short-run during the ICA period; in contrast, retail prices responded to changes in international prices in the post-ICA period. We find differences between the two European countries and the United States. Our results indicate that changes in international prices influenced U.S. retail prices in both periods. Nonlinear impulse response analysis indicates that ICA elimination increased the speed of adjustment toward the long-run equilibrium, given a shock in international coffee prices. Overall, our results show that ignoring nonlinearities and asymmetries in price transmission may lead to incorrect impact assessment of policies affecting global agricultural supply chains.

 
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A Comprehensive Evaluation of USDA Cotton Forecasts
Olga Isengildina-Massa, Stephen MacDonald and Ran Xie
Year: 2011
 

Abstract

This study provides a comprehensive examination of accuracy and efficiency of all USDA cotton supply and demand estimates for the U.S. (including unpublished price forecasts), China and rest of the world (ROW) over1985/86 through 2009/10. Our findings show that USDA overestimated China’s exports and underestimated China’s domestic use and ROW imports. Based on correlation of forecast errors with levels, estimates of U.S. domestic use, ending stocks and China’s exports were too extreme while forecasts of China’s ending stocks and ROW production and exports were too conservative. Correlations with past errors suggest that USDA tends to repeat errors in ROW production forecasts and overcorrect errors in ROW exports forecasts. Significant positive correlation between subsequent revisions indicating forecast “smoothing” was detected in the U.S. production, domestic use, exports and ending stocks forecasts, China’s imports, domestic use and exports forecasts and the ROW production and domestic use forecasts. While China’s ending stocks and production forecasts significantly improved over time, (unpublished) U.S. price forecasts became worse. Based on correlations of errors we conclude that better forecasts of U.S. ending stocks and domestic use forecasts, China’s imports and ROW ending stocks and exports forecasts are essential for improving U.S. cotton price forecasts.

 
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The Impact of Ethanol Production on Local Corn Basis
Kathleen Behnke and T. Randall Fortenbery
Year: 2011
 

Abstract

The focus of this study is on the impact local ethanol plants have on corn basis. Basis is the difference between the local cash price and the nearby futures contract price, and accounts for variation in the supply and demand in the local market relative to the national market. It is predicted that the entrance of an ethanol plant into a local cash market will increase corn demand, resulting in an increased cash price relative to futures.

The data employed consists of cash corn prices from 153 grain buyers in eight different Midwestern states from Fall 1999 through Summer 2009. In addition to affects from local ethanol production, it is predicted that basis is influenced to by the ratio of local to national corn production, transportation costs, storage opportunity costs, and seasonal factors. To estimate corn basis performance a spatial error component model is adopted that accounts for both spatial dependencies and panel structures in the data.

Results show that ethanol production within a 50-mile region of a county centroid has a small yet positive impact on local corn prices. The estimated impact of a 50 million gallon per year plant is a 0.425 cent per bushel increase in basis. These findings are smaller than the impacts found in previous work using a more limited time frame, but found to be consistent with earlier work when the time series is truncated to match sample periods from previous work. This suggests that some of the local price impacts dissipate with time.

 
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Examining the Relationship Between Physical Stocks of Commodities and Open Interest in Related Futures Markets
Daniel Sanders, Corinne Alexander and Matthew Roberts
Year: 2011
 

Abstract

The price volatility observed in futures markets, beginning in 2006 and continuing through to the present, has posed challenges to commercial traders attempting to use these markets to hedge their price risk. Additionally, speculative activity in these markets is seemingly on the rise, with large index funds drawing the ire of many as a possible driver of price volatility and high price levels. Taken in concert, these issues have led some to question the ability of the markets to continue to provide for adequate hedging functionality. In this paper, we attempt to determine if the rate at which commercial traders hedge in the markets has changed by testing for structural change in the relationship between open interest and physical grain stocks. A significant structural break is found in the wheat market in late 2004. A more detailed examination of the break is done by incorporating smooth transition and threshold models, with the positive relationship between open interest and stocks shown to decline to statistically zero around the structural break. Given the development of non-convergence in the wheat market at this time, it suggests that wheat hedgers might be using alternative hedging outlets. Overall, the estimated models show generally poor fits, indicating that there might be other factors than are present in the structural model influencing hedgers’ positions in futures markets.

 
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Identifying Jumps and Systematic Risk in Futures
Sijesh C. Aravindhakshan and B. Wade Brorsen
Year: 2011
 

Abstract

A variety of multivariate jump-diffusion models have been suggested as models of asset prices. This paper extends the literature on (joint) mixed jump-diffusion processes in futures markets by using the CRB index futures to represent systematic risk in commodity prices. We derive (joint) mixed bivariate normal distributions and likelihood functions for estimating the parameters of jump-diffusion processes. Likelihood ratio tests are used to select among nested models. The empirical results show the presence of downside jumps and significant systematic risk in wheat futures returns. Amin and Ng’s (1993) model with a single counter of jumps fits better than other jump-diffusion processes considered. The jump components did not have significantly more systematic risk than the continuous component. In terms of wheat prices, one standard deviation jumps are 14 cents per bushel and two standard deviation jumps are 29 cents per bushel and are within the price limits. These jumps occur once in every six business days and are mostly crashes.

 
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Volatility Spillovers in the U.S. Crude Oil, Corn, and Ethanol Markets
Andres Trujillo-Barrera, Mindy Mallory, and Philip Garcia
Year: 2011
 

Abstract

This paper analyzes volatility spillovers from energy to agricultural markets in the U.S. which have increased due to strong crude oil price volatility and the large growth in ethanol production in the period 2006-2011. Results suggest that spillovers from crude oil to corn and ethanol markets are similar in magnitude over time, and are particularly significant during periods of high turbulence in the crude oil market. Volatility spillovers between corn and ethanol also exist, but primarily from the corn to ethanol market. The findings provide clear evidence of the stronger linkages between corn and ethanol that have been created during the biofuel era.

 
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Highly variable prices or excessive volatility? Is a supply management program warranted? An Extension Dairy Economist’s Perspective
Cameron S. Thraen
Year: 2011
 

Abstract

During the past decade the U.S. dairy market has been subject to periodic swings in dairy commodity and milk prices. The U.S. All Milk price reached an historic high of $21.90 (nominal dollars) per hundredweight in November, 2007 before retreating to a low of $11.30 recorded in June of 2009. This rapid decline in milk price has become the focal point for the claim of ‘excess volatility’ in milk prices and a call for the introduction of a federal government mandated supply management program for U.S. dairy production sector. This program, if adopted, would be included in the next dairy title of the 2012 agricultural farm legislation, and is outlined in two bills, the Costa bill HR5288 and the Sanders bill S-82010. The intent of these proposed programs would be to greatly diminish this perceived ‘volatility’ in milk price. The research approach will be to use modern time-series modeling techniques to determine the nature of the ‘volatility’ versus ‘variability’ in milk and dairy product prices over the past ten years. The empirical analysis will assess the variability for both dairy commodity prices (butter, cheese, nonfat dry milk, and whey), and a proxy for the Federal Order 33 Blend Price. The results of this empirical investigation reveal that while dairy commodity prices exhibit significant periods of volatility and volatility spikes, there is no evidence that this volatility is growing over time. Following upward swings in volatility dairy prices and the farm milk price return to lower levels represented by the long run variance for each price series.

 
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'Investing' in Commodity Futures Markets: Are the Lambs Being Led to Slaughter?
Dwight R. Sanders and Scott H. Irwin
Year: 2011
 

Abstract

Investments into commodity-linked investments have grown considerably over the last five years as individuals and institutions have embraced alternative investments. However, unlike investments in equities or real estate, commodity futures markets produce no earnings and are arguably not even a capital asset. So, the source of returns and the expected returns for commodity futures investments is unclear. This paper examines the history of returns for static long-only futures investments over five decades. The research highlights the following features of commodity futures investments: 1) returns to individual futures markets are zero, 2) returns to futures market portfolios depend critically on the weighting schemes and the embedded trading strategy, and 3) historical returns are not statistically different from zero and are driven by price episodes such as 1972-1974.

 
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Dynamic Inter-relationships in Hard Wheat Basis Markets
William W. Wilson and Dragan Miljkovic
Year: 2011
 

Abstract

The basis values for hard red spring wheat (HRS) have escalated radically, experienced extraordinary levels of volatility (risk), have been subject to a squeeze during 2008, and all these have important implications for market participants. These observations are particularly important to marketers in the Northern Great Plains in the United States, as well as for Canadian marketers. The purpose of this paper is to develop a model to explore the dynamic relationships and interdependencies among terminal market basis values for milling quality higher-protein wheat. Specifically, we seek to identify factors impacting basis values for 13, 14, and 15% protein HRS wheat in addition to the intermakret wheat spread between Minneapolis and Kansas City wheat futures. We specify a vector autoregression (VAR) model to explore these relationships. Exogenous structural variables are specified in addition to dynamic inter-relationships including seasonal variability, inter-temporal variability and dynamic interdependencies among these markets and relationships. The results of interest are that: 1) basis values for these wheat markets been trending up, and have become more volatile; 2) factors impacting this variability is primarily the protein level in HRS, and production of HRW and Canadian (on high protein basis); 3) HRW protein supplies are not significant in the basis equations, but, do have an impact on the interrmarket wheat futures spread; 4) Quality factors have a significant impact on basis values, notably vomitoxin, falling numbers and absorption. There are also dynamic interrelations that are important. Important is that all four prices converge quickly towards long-term equilibrium. In addition there are seasonal impacts, dynamic bases interactions, trends, and lagged impacts of protein levels.

 
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How Do Canadian Wheat Producers’ Make Marketing Decisions?
Stefanie Fryza and Fabio Mattos
Year: 2011
 

Abstract

The purpose of this paper is to investigate how Western Canadian wheat producers’ make their marketing decisions. In Canada wheat must be marketed through the Canadian Wheat Board (CWB), which offers several marketing contracts providing distinct combinations of return, risk, and cash flow. Pool pricing is the default alternative in which the CWB markets the grain for producers, while Producer Payment Options (PPO) represents instruments that producers can use to price their wheat outside the pool. Results indicate that previous use of a PPO contract tends to reduce its use in the current year. Previous performance is also found to be an important variable, with higher performance in previous year leading to more use of PPO contracts in the current year. In addition, producers seem to follow price signals to choose marketing contracts, specially the difference between the futures price and the expected pool price.

 
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Testing the Performance of Multiproduct Optimal Hedging with Time-Varying Correlations in Storable and Non-storable Commodities
Hernan A. Tejeda and Barry K. Goodwin
Year: 2011
 

Abstract

Recent steady growth in the volatility of commodity markets, and the increasing need for proper risk management tools in production settings that make use of inputs and outputs in futures markets, may be addressed via multiproduct hedging. This study determines and contrasts the effectiveness of multiproduct optimal hedging – that incorporate time-varying correlations – between storable and non-storable commodity settings, especially during recent periods of increased volatility. A soybean complex is considered for storable production-related commodities, and a feedlot operator is considered for non-storable production-related commodities.

Multiproduct optimal time-varying hedge ratios are determined via a multivariate state dependent model of regime switching dynamic correlations. This model estimates time-varying correlations for multiple series in different correlation regimes (i.e., the conditional correlations matrix is not constant in this model). Two correlation regimes are estimated for the time periods considered, for both storable and non-storable production settings. More importantly, significant improvement of multiproduct hedging is determined for the storable commodity setting – soybean complex- over simple hedging strategies with time-varying correlations and the naïve strategy (1:1 hedge ratio). However, there is no significant improvement found for the nonstorable commodity setting – feedlot operator – over simple hedging strategies with time-varying correlations; yet there is improvement over a naïve hedging strategy. These latter results are corroborated using two different data sets for cash prices of feeder and live cattle.

 
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A Quantile Regression Approach to Analyzing Quality-Differentiated Agricultural Markets
Anton Bekkerman, Gary W. Brester, and Tyrel McDonald
Year: 2011
 

Abstract

Hedonic models are commonly used to quantify the value of characteristics implicit in a product’s price. However, when products are heterogenous across quality levels, using traditional parametric methods for estimating characteristic values may provide poor inferences about quality effects. We propose using a quantile regression framework for estimating the value of characteristics in quality-differentiated products. Semi-parametric quantile regressions allow the data to flexibly identify and estimate quality effects across a conditional price distribution. Using purchase price data from a bull auction, we show complementary non-linear relationships exist between quality and bull carcass and growth traits. Improved precision in understanding consumer valuation of product characteristics across quality market segments can help producers tailor products for each segment.

 
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A Spatial Approach to Estimating Factors that Influence the Corn Basis
Michael K. Adjemian, Todd Kuethe, Vince Breneman, Ryan Williams, Mark Manfredo, and Dwight Sanders
Year: 2011
 

Abstract

It is well known that supply and demand fundamentals at any location affect the local basis. Because grain markets are tied together by spatial arbitrage, the local basis may also be affected by the supply and demand factors at neighboring locations. Whether or not this is the case, the corn basis is highly clustered across the United States; as such, OLS estimates of basis determinants may be inconsistent. We apply a spatial econometrics framework to adequately control for spatial effects, and find that the county-level corn basis is characterized by spatial spillovers: supply and demand factors in a given county affect its own basis, but also radiate out over space affecting the basis at neighboring counties. We find that unobserved basis determinants are also spatially correlated.

 
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Returns to Individual Traders in Agricultural Futures Markets: Skill or Luck?
Nicole M. Aulerich, Scott H. Irwin, and Philip Garcia
Year: 2011
 

Abstract

Using individual trader data from the CFTC reporting system for the period January 2000 to September 2009, the paper investigates whether non-commercial traders in the corn, live cattle, and coffee futures markets persist in making profits. Two out-of-sample measures of skill—the Fisher Exact ranking test and a test to assess significant differences in the magnitude of profits of the top and bottom traders—are used to analyze trader’s ability to consistently perform well for monthly, quarterly, and annual time horizons. The findings identify significant persistence in rankings—traders in the top half of the profit distribution in a time period tend to stay in the top half in the next period. Differences in magnitude of profitability between the top and bottom deciles also provide support that persistent skill exists among the top 10% of traders. Detailed examination of annual rankings for those traders who were most continuously in the markets further reveals persistence in profits for a smaller subset of traders, and some indication of persistence in the face of losses.

 
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The Role of Long Memory in Hedging Strategies for Canadian Commodity Futures
Janelle Mann
Year: 2011
 

Abstract

This research paper investigates whether ICE futures contracts are an effective and affordable strategy to manage price risk for Canadian commodity producers in recent periods of high price volatility. Long memory in volatility is found to be present in cash and futures prices for canola and western barley. This finding is incorporated into the hedging strategy by estimating hedge ratios using a FIAPARCH model. Findings indicate that the ICE futures contracts for canola is an effective and affordable means of reducing price risk for canola producers and should be considered as part of a price risk management strategy. On the other hand, the findings indicate that the ICE futures contract for western barley is not as effective as a means of reducing price risk for western barley producers; however, it is affordable. At the current time, western barley producers should consider alternative means of price risk management; however, the ICE futures contract should be reconsidered after modifications to contract specifications come into effect.

 
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Oligopsony Fed Cattle Pricing: Did Mandatory Price Reporting Increase Meatpacker Market Power?
Xiaowei Cai, Kyle W. Stiegert,and Stephen R. Koontz
Year: 2011
 

Abstract

The Livestock Mandatory Price Reporting Act became law in April 2001 with the intent to provide more transparent market information to cattle producers. A criticism of mandatory price reporting (MPR) is that the increased price transparency may actually increase oligopsony power exercised by beef packers. We examine beefpacking margins using time periods before and after MPR was implemented with a Markov model that tests for switching between cooperative and noncooperative pricing. Switching is indicative of noncompetitive conduct and we examine the duration and magnitude of market power. One key finding is that market power is two times higher after MPR than before. The second is that, while this study produces some of the largest measures of market power associated with fed cattle pricing, market power remains rather small and is consistent with prior research. Last, we offer the caveat that there is more occurring in fed cattle and beef markets during last 20 year than the transition from voluntary to mandatory price reporting. So MPR is likely not the only cause of increased market power. But there is clearly more market power exercised in fed cattle markets after 2001 than before.

 
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Futures Market Failure
Philip Garcia, Scott H. Irwin, and Aaron D. Smith
Year: 2011
 

Abstract

In a well-functioning futures market, the futures price on the expiration date equals the price of the underlying asset on that date. An unprecedented episode of non-convergence in Chicago Board of Trade (CBOT) corn, soybeans, and wheat began in late 2005, and with the exception of some brief periods, largely persisted through 2010. Most recently, the Kansas City Board of Trade (KCBOT) wheat contract also has demonstrated convergence problems. During this unprecedented and extended episode of non-convergence, futures contracts have expired at prices up to 35 percent greater than the prevailing cash grain price. Using a rational expectations commodity storage model, we show how such non-convergence can be produced by the institutional structure of the delivery market. Specifically, we show how a wedge between the marginal cost of storing the physical commodity and the cost of carrying the delivery instrument causes non-convergence. We fit the model to corn, soybeans, and wheat and find strong support for our model.

 
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