NCCC-134
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Have Commodity Index Funds Increased Price Linkages between Commodities?
Jeffrey H. Dorfman and Berna Karali
Year: 2012
 

Abstract

To shed more light on the ongoing debate on the role of commodity index funds on recent commodity price spikes, we investigate the linkages between commodity futures prices surrounding the time period of increased index fund activity. We take a Bayesian approach to test stationarity and cointegration of commodity pairs and trios. We find that simple correlation coefficients between futures prices and the probability of nonstationarity of the series have increased over time as the size of index fund trading became larger. However, our cointegration test results show no evidence for an increase in cointegration.

 
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An Evaluation of the USDA Sugar Production and Consumption Forecasts
Karen E. Lewis and Mark R. Manfredo
Year: 2012
 

Abstract

The performance of the USDA domestic sugar production and consumption forecasts for marketing years 1993/1994 through 2009/2011 was evaluated. Using USDA sugar forecast information, U.S. sugar policy attempts to operate at no cost to the government by maintaining sugar prices above the government loan-rate. Results suggest no evidence that U.S. sugar policy is negatively impacted by the USDA sugar production and consumption forecasts. Also, new policies formed under the 2008 Farm Bill are not impaired by USDA sugar production and consumption forecasts. Overall, the results suggest that the USDA has done an outstanding job of forecasting domestic sugar production and consumption over the sample period.

 
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Price Explosiveness and Index Trader Behavior in the Corn, Soybean, and Wheat Futures Markets
Xiaoli Liao-Etienne, Scott H. Irwin and Philip Garcia
Year: 2012
 

Abstract

The purpose of this paper is to assess whether index investment Granger causes grain futures price movements during explosive periods. A forward and backward recursive procedure developed by Phillips, Shi, and Yu (2012) is used to detect and date-stamp explosive periods in in the price of corn, soybean, and wheat futures traded on the CBOT, as well as wheat futures traded on the KCBT between January 2004 and February 2012. The statistical tests indicate that most of these grain futures markets experienced explosive periods between the end of 2007 and first half of 2008, as well as in the second half of 2010. If CITs are indeed responsible for the sharp price fluctuations as claimed by Masters (2008, 2009) and others, they are mostly likely to have led the price movement during these explosive periods. Using dummy variables to reflect the explosive periods identified with the PSY procedure, we investigate the relationship between commodity index (CIT) positions and changes in futures prices. We find that no Granger causality can be established from changes in CITs net long positions to returns in corn, soybeans, and KC wheat futures in either explosive or non-explosive periods, consistent with the results from the traditional Granger causality test. For wheat futures traded on the CBOT, estimation results show that CITs Granger cause returns in explosive and non-explosive periods. Examination of the impulse response function, however, suggests that the effect is relatively small and dissipates quickly. Overall, the results from the modified Granger causality test differentiating explosive from non-explosive periods provide additional evidence that CITs are mostly likely not responsible for the large price movement observed in grain futures between January 2004 and February 2012.

 
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The Behavior of Bid-Ask Spreads in the Electronically Traded Corn Futures Market
Xiaoyang Wang, Philip Garcia and Scott H. Irwin
Year: 2012
 

Abstract

This paper is the first to study liquidity costs based on actual observed bid-ask spreads (BAS) in commodity futures markets. Using electronically-traded corn futures contracts, we calculate the BAS directly faced by market participants, avoiding estimation problems encountered previously. Over the extended horizon that a contract is traded there exist a pronounced non-linear U-shaped maturity pattern, and a strong seasonality consistent with the term structure of implied volatilities. Statistical analysis in the nearby and next nearby periods, in which most trading activity occurs, indicates that the BAS is generally small (well below two ticks), despite the turbulent market in the 2008 to early 2010 sample period. As in open outcry markets, the BAS responds to daily volume and price volatility, particularly over the last 40 non-expiration month trading days. For the next nearby contracts, a significant declining trend exists in the BAS independent of daily volume and volatility. In both periods, USDA Grain Stock and Production-WASDE announcements significantly widen the BAS, as do short-term price trends. The index fund roll has little impact on the BAS, but contract specific effects are present reflecting a seasonal pattern where the BAS is lowest in December, and highest in September. Week-day effects are relatively weak in magnitude or non-existent.

 
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Usage Determinants of Fed Cattle Pricing Mechanisms
Matthew A. Diersen and Scott W. Fausti
Year: 2012
 

Abstract

Proposed cattle slaughter facilities in the upper Midwest have renewed interest among feedlot operators in the most appropriate mechanism to use when selling cattle. Buyers are also interested in the mechanisms that may have different benefits and seasonal patterns based on established behavior of other buyers in the region. In this paper we model the shares of fed cattle traded using different pricing mechanisms. The intent is to build a forecasting model of shares considering fundamental factors and seasonality. There is regional variation in the use of mechanisms. A Seemingly Unrelated Regression estimation procedure was used to analyze market shares. More variability of forward pricing and negotiated live pricing methods was explained compared to formula pricing and grid pricing methods.

 
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Price Discovery, Volatility Spillovers and Adequacy of Speculation in Cheese Spot and Futures Market
Marin Bozic and T. Randall Fortenbery
Year: 2012
 

Abstract

We investigate price discovery, volatility spillovers and impacts of speculation in the dairy sector. Examining the time series properties of cheese cash and implied futures price we find that the unit root hypothesis is strongly rejected for cash prices, while unit roots cannot be rejected for nearby futures prices in the framework that carefully controls for rollovers. To explain this result, we built a model that illustrates the time series properties of the nearby futures price series for a futures contract written on a second-order stationary cash series and identified the mean-reverting nonlinear dynamics that will occur at rollovers. Given the time series properties of the cash and futures series we propose an error-correction model using spreads between cash and the second nearby futures instead of the cointegration vector. To account for volatility dynamics we propose an extension of the BEKK variance model that we refer to as GARCH-MEX. That model does not restrict the sign of the additional regressors on the conditional variances, and can easily insure positive-definiteness of the conditional covariance matrix. We find that the flow of information in the mean model is predominantly from futures to cash, while volatility spillovers are bidirectional. It is possible that cash prices that include unfilled bid/offers react differently to increases in volatility in futures prices than sales cash prices, indicating that liquidity in the cash market is reduced with increase in conditional volatility of the futures price. Utilizing GARCH-MEX model we find strong evidence against the hypothesis that excessive speculation is increasing the conditional variance of futures prices. If anything, speculation may in fact be inadequate, and further research with daily speculative positions and high-frequency futures prices is needed to identify the effect of increased speculation on realized volatility of futures prices, bid-ask spread and magnitude of slippage.

 
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The Food Corporation of India and the Public Distribution System: Impacts on Market Integration in Wheat, Rice, Pearl Millet, and Corn
Mindy Mallory and Kathy Baylis
Year: 2012
 

Abstract

This paper examines the spatial integration of major staple commodity markets in India. We consider wheat, rice, pearl millet, and corn markets. This set represents the two most highly regulated crops, wheat and rice; and two that are regulated to a lesser degree, pearl millet and corn. Our data come from the states of Bihar, Haryana, Uttar Pradesh, and West Bengal, states that produce a large share of India’s cereal grains. Access to food remains an important issue for India as it develops. Because of this, the Indian government regulates the markets for staple foods heavily, requiring almost all grain be marketed through government licensed mandis. The government enforces a minimum price in the regulated markets by placing government buyers in each market that will purchase any amount of grain meeting minimum quality standards at the minimum support price. This activity results in the government being the primary entity engaged in the storage of staple food crops. These market interventions discourage private investment in storage capacity among farmers and traders who handle grain in the private sector, which could impact market integration and efficient price transmission. However, we find the strongest evidence for market integration in the rice markets, which is one of the most regulated of the crops considered. Therefore, there seems to be some benefit from the government’s market making activities that may compensate for a lack of infrastructure to facilitate market integration

 
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Pass-Through and Consumer Search: An Empirical Analysis
Timothy J. Richards, Miguel I Gómez and Jun Lee
Year: 2012
 

Abstract

Retail-price pass-through is one of the most important issues facing manufacturers of consumer- packaged goods. While retailers tend to pass wholesale prices through to consumers quickly and completely, they often do not pass trade promotions on. Currently, asymmetric pass-through is commonly thought to result from retailers. Exercise of market power. Alternatively, it may be due to consumer search behavior, and retailers' competitive response. We test this theory using a panel threshold asymmetric error correction model (TAECM) applied to wholesale and retail scanner data for ready-to-eat cereal for a number of retailers in the Los Angeles metropolitan market. We find that consumer search behavior contributes significantly to imperfect pass-through. By allowing pass-through to depend on market power and consumer search costs, we find results that are contrary to the conventional wisdom. Namely, market power causes retail prices to fall quickly and rise slowly, while consumer search costs cause retail prices to rise quickly and fall slowly precisely the "rockets and feathers" phenomenon.

 
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Road Block to Risk Management - How Federal Milk Pricing Provisions Complicate Class 1 Cross-Hedging Incentives
John Newton and Dr. Cameron Thraen
Year: 2012
 

Abstract

In 2000 the USDA introduced new methods to price milk used to produce class 1 bev- erage milk in the U.S. This shift in the dairy policy complicated hedging incentives by exposing traders to basis risk and increasing milk price uncertainty. We use empir- ical analysis to compute generalized optimal hedge ratios and estimate autoregressive models to forecast the basis associated with cross-hedging class 1 milk using exchange traded milk futures. The results indicate that while milk futures contracts do provide risk management opportunities for cash market participants, market participants are trading price risk for highly variable basis risk. Exchange traded milk futures contracts only capture a portion of the variance in the beverage milk cash price, the closing basis fails to converge to some predictable level, and for risk-averse agents basis reduces the utility gained from hedging. Policy and market options may be considered to improve risk management in the beverage milk sector. These options include: allow forward contracting in class 1 milk, alternative price discovery methods, and the introduction of an exchange traded uid milk contract.

 
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Analyzing Crop Revenue Safety Net Program Alternatives and Implications on Marketing Decisions
Jim A. Jansen, Bradley D. Lubben, and Matthew C. Stockton
Year: 2012
 

Abstract

This study evaluates the crop revenue effects of combining federal farm income safety net programs, crop insurance policies, and marketing arrangements. Eight representative farms across Nebraska are used to stochastically simulate the financial impact of nine risk management strategies to determine the optimal outcome during the 2011 production year. Procedures utilized to evaluate the stochastic results included the Expected Value, Coefficient of Variation, Stochastic Dominance, StopLight, and Stochastic Efficiency with Respect to a Function. Results indicate that out of the set of predefined strategies, the portfolio combination involving the government program choice of the Direct and Counter-Cyclical Program, crop revenue insurance with the fall harvest option, and hedging for the simulated time period provides the optimal outcome across the majority of representative farm scenarios in 2011.

 
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The Increasing Participation of China in the World Soybean Market and Its Impact on Price Linkages in Futures Markets
Maria Alice Móz Christofoletti,Rodolfo Margato da Silva,and Fabio Mattos
Year: 2012
 

Abstract

This paper examines price linkages between soybean futures contracts traded in China, U.S, Brazil and Argentina for the period ranging from 2002 to 2011. The main findings show that U.S. prices still appear to have a dominant role to explain price changes in international markets. Results also indicate stronger linkages between prices in China and in the other three markets, especially after 2006. This result suggests the Chinese market has become more integrated with international markets in recent years, which might reflect the growing participation of China in international trade and the development of its soybean futures contract.

 
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A Jump Diffusion Model for Agricultural Commodities with Bayesian Analysis
Adam Schmitz, Zhiguang Wang, and Jung-Han Kimn
Year: 2012
 

Abstract

Stochastic volatility, price jumps, seasonality, and stochastic cost of carry, have been included separately, but not collectively, in pricing models of agricultural commodity futures and options. We propose a comprehensive model that incorporates all four features. We employ a special Markov Chain Monte Carlo algorithm, new in the agricultural commodity derivatives pricing literature, to estimate the proposed stochastic volatility (SV) and stochastic volatility with jumps (SVJ) models. Overall model fitness tests favor the SVJ model. The in-sample and out-of-sample pricing and hedging results for corn, soybeans and wheat generally, with few exceptions, lend support for the SVJ model.

 
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Marketing Choices by Texas Cotton Growers
Jason D. Pace and John R. C. Robinson
Year: 2012
 

Abstract

Recent changes in farm programs, cotton supply and demand fundamentals, and cotton price patterns have likely shifted how producers market their cotton. This paper examines cash marketing choices by southwestern cotton producers in 2010. Hedging is included an explanatory variable, along with other independent variables studied in previous research. Producer marketing behavior was modeled in a multinomial logit framework as a discrete choice among forward contracting with a merchant, post-harvest cash contracting with a merchant, contracting with a merchant pool, or contracting with a cooperative pool. Data were collected from a mail survey of the population of cotton growers in Texas, Oklahoma and Kansas. The most important determinants of cotton cash marketing choices were 1) prior participation in cooperative pools, beliefs about the value of pre-harvest pricing, beliefs about the performance of merchant pools, willingness to accept lower prices to reduce risk, and several socio-economic variables.

 
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How Does “Cost Risk”Influence Producers' Decision to Hedge?
Elisson de Andrade and Fabio Mattos
Year: 2012
 

Abstract

Several studies have investigated transaction costs in futures trading and found that optimal hedge ratios tend to be smaller in their presence. However, those studies consider transaction costs deterministically, i.e. hedgers know the exact amount of transaction costs when the hedge is placed. The current research relies on the notion that some transaction costs are uncertain when the producer decides to place a hedge. The uncertainty originates from the fact that some costs, such as margin deposits and taxation, depend on the trajectory of futures prices during the hedging period. The objective of the paper is to investigate how the uncertainty associated with transactions costs can influence producers’ decision to hedge. In addition, a broader range of costs involved in hedging operations will be introduced. Two main results emerge from this study. First, consistent with previous studies, introduction of transaction costs in futures trading leads to smaller hedge ratios. Second, allowing for uncertainty in transaction costs does not seem to have a larger impact on hedge ratios. In fact, the introduction of stochastic transactio

 
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Commodity Price Comovement: The Case of Cotton
Joseph P. Janzen, Aaron D. Smith, and Colin A. Carter
Year: 2012
 

Abstract

During the commodity price boom and bust of 2007-2008, cotton futures prices rose and fell dramatically in spite of high levels of inventory. At the same time, correlation between cotton and other commodity prices reached historically high levels. These two observations underlie concerns that cotton prices during this period were poor signals of cotton market fundamentals and that the cotton market was ’taken along for a ride’ with other commodities. The apparent coincidence of extreme price movement across a broad range of commodities requires an explanation. Were cotton prices driven by the same set of macroeconomic factors as the other commodities? Did cotton markets suffer from supply disruptions at the same time that the other commodities faced disruptions? What was the role of futures market speculators and the rise of commodity index trading?

Economists have been writing about excessive or unexplained comovement among commodity prices since at least Pindyck and Rotemberg (1990). Using this literature as a starting point, we identify potential explanations for commodity price comovement. Past studies have accounted for macroeconomic activity, and cotton-specific supply and demand changes. Tang and Xiong (2010) suggest that speculative pressure due to broad-based commodity index trading may also cause comovement among commodity prices. We develop and estimate a structural vector autoregression model to test the relative contribution of these effects to observed cotton prices. We find that supply and demand shocks specific to the cotton market are the major source of cotton price variation. There is scant evidence of comovement-type effects. While most cotton price spikes are driven by shocks to current net supply, the 2007-2008 spike was caused by higher demand for inventories.

 
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Forecasting Corn and Soybean Basis Using Regime-Switching Models
Daniel J. Sanders and Timothy G. Baker
Year: 2012
 

Abstract

Corn and soybean producers in the core production areas of the U.S. have experienced a notable jump in basis volatility in recent years. In turn, these increasingly erratic swings in basis have increased producers’ price risk exposure and added a volatile component to their marketing plans. This paper seeks to apply regime-switching econometrics models to basis forecasting to provide a model that adjusts to changing volatility structures with the intent of improving forecasts in periods of volatile basis. Using basis data from 1981 through 2009 from ten reporting locations in Ohio, we find that although models using time series econometrics can provide better short run basis forecasts, simple five year moving average models are difficult to improve upon for more distant forecasting. Moreover, although there is statistical evidence in favor of the regime-changing models, they provide no real forecasting improvement over simpler autoregressive models.

 
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Exploring Underlying Distributional Assumptions of Livestock Gross Margin Insurance for Dairy
Marin Bozic, John Newton, Cameron S. Thraen and Brian W. Gould
Year: 2012
 

Abstract

Livestock Gross Margin Insurance for Dairy Cattle (LGM-Dairy) is a recently introduced tool for protecting average income over feed cost margins in milk production. In this paper we examined the assumptions underpinning the rating method used to determine premium charged for LGM-Dairy insurance contract. The first test relates to assumption of lognormality in terminal futures prices. Using high-frequency data for futures and options for milk, corn and soybean meal we estimate implied densities with flexible higher moments. Simulations indicate there is no strong evidence that imposing lognormality introduces bias in LGM-Dairy premiums. The rest of the paper is dedicated to examining dependency between milk and feed marginal distributions. LGM-Dairy rating method imposes the restriction of zero conditional correlation between milk and corn, as well as milk and soybean meal futures prices. Using futures data from 1998-2011 period we find that allowing for non-zero milk-feed correlations considerably reduces LGM-Dairy premiums for hedging profile with substantial feed amounts declared. Further examination of the nature of milk-feed dependencies reveals that Spearman’s correlation coefficient is mostly reflecting tail dependence. Using empirical copula approach we find that non-parametric method of modeling milk-feed dependence decreases LGM-Dairy premiums more than a method that allows only for linear correlation. Unlike all other situations in portfolio risk assessment where extremal dependence increases risk, in agricultural margins, tail dependence between inputs and outputs may actually decrease insurance risk, and reduce actuarially fair premiums.

 
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Foreign Exchange Pass-Through and the Potential Use of Grain Export-Denominated Trade Weighted Indices
Allister Keller and Ron McIver
Year: 2012
 
No Abstract Available

 
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Density Forecasts of Lean Hog Futures Price
Andres Trujillo-Barrera, Philip Garcia, and Mindy Mallory
Year: 2012
 

Abstract

High price variability in agricultural commodities increases the importance of accurate forecasts. Density forecasts estimate the future probability distribution of a random variable, offering a complete description of risk. In this paper we investigate density forecast of lean hog prices for the 2002-2012 period for two weeks horizons. We estimate historical densities using GARCH models with different error distributions and generate forward looking implied distributions, obtaining risk-neutral densities from the information contained in options prices. Real-world densities, which incorporate risk, are obtained by parametric and non parametric calibration of the risk-neutral densities. Then the predictive accuracy of the forecasts is evaluated and compared. Goodness of fit and out of sample log-likelihood comparisons indicate that real-world densities outperform risk-neutral and historical densities, suggesting the presence of risk premiums in the lean hog markets. For the historical density forecasts, GED error distributions for the GARCH estimations show an adequate predictive accuracy. Meanwhile, historical densities with normal and t-distributions show a discrete performance.

 
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The Price Responsiveness of U.S. Wheat Export Demand by Class
Daniel O’Brien and Frayne Olson
Year: 2012
 

Abstract

The objective of this research is to analyze the factors affecting the price responsiveness of disaggregated classes of U.S. wheat exports. Factors examined in this study that are likely to influence U.S. exports on a class-by-class basis include wheat prices – own price and cross price effects from wheat classes and competitive substitutes such as feedgrains; supply-demand balances by wheat class for major export sellers & import buyers; ocean freight costs for U.S. grain exports; and exchange rates for the U.S. dollar & other currencies. Using public data from domestic and international sources, single equation models of U.S. wheat export demand were developed, with one group of U.S. wheat export competitor models by wheat class, and a second group of U.S. wheat export share models by class. Results indicate that both own price and cross price responsiveness of U.S. exports was found in hard red winter and hard red spring wheat class exports. Soft white wheat and soft red winter wheat exports were unresponsive to own or cross price effects, but instead responded to changes in world wheat and corn supply-demand balances. Ocean freight rates, U.S. currency exchange rates and quarterly period seasonal factors also at times influenced U.S. wheat exports in these results. Additional factors likely to influence class-by-class U.S. wheat exports that are not explicitly examined in this study include the proportion of food versus feed quality wheat by class as is most common in individual exporting and importing countries, and protein and quality factors for U.S. wheat by class. Future applied research efforts will need to account for these factors.

 
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Reexamining the Interaction between Private and Public Stocks
Carl R. Zulauf
Year: 2012
 

Abstract

It is commonly-accepted that public stocks reduce private stocks. In contrast, empirical estimates range from no displacement to 100 percent displacement. Utilizing the concept of options, a conceptual model was developed. It implies the displacement effect is nonlinear, decreasing as public stocks increase. Displacement reaches zero when public stocks are large enough to cover all shortfalls in quantity demanded at the public stock release price. In addition, the displacement effect depends on the slope parameter of the commodity’s demand equation, the probability distribution of price, and the relationship between market price and public stock release price. A bootstrap regression analysis of carryout stocks of U.S. wheat from the 1953-54 though 1971-72 crop years was conducted. Consistent with the conceptual model, the displacement effect decreased as the amount of public stocks increased. Zero displacement was reached when public stocks equaled 100 percent of annual consumption. The displacement effect of the first unit of U.S. wheat public stocks did not differ statistically from 100 percent. While this analysis finds that the displacement of private stocks is a substantial cost of a public stock policy, it also suggests that the accumulation of public stocks can enhance total stocks, especially if the country is willing to accept the large private stock displacement cost of the first units of public stocks. Thus, the policy decisions regarding public stocks are more interesting than if the displacement of private stocks by public stocks is either none or 100 percent.

 
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