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Hedging and Speculative Pressures: An Investigation of the Relationships among Trading Positions and Prices in Commodity Futures Markets
Georg V. Lehecka
Year: 2013
 

Abstract

This study provides a systematic empirical investigation of lead-lag relationships among trading positions and prices in commodity futures markets. It employs Toda-Yamamoto Granger-causality tests applied on a variety of measurements of hedging, speculative, and index trader position activities and futures prices. Weekly futures market positions from the Commodity Futures Trading Commission (CFTC) and prices are examined for 24 commodities (1995 to 2011) based on Commitments of Traders (COT) reports and twelve commodities (2006 to 2011) based on Commodity Index Trader Supplement (CIT) reports. In particular, this study empirically examines whether pressures on prices due to hedging and speculative activities can be identified, and whether they have changed due to structural changes in commodity futures markets. Results suggest little systematic lead-lag relationship from hedging and speculative activities to prices. In contrast, there is strong evidence that prices tend to lead traders’ hedging and speculative activity. These results appear to be generally persistent over commodities, measurements of hedging and speculation, and periods. In summary, hedging and speculative pressures may not be helpful in explaining prices in commodity futures markets; to the contrary, prices may cause traders to change their positions.

 
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Determination of Factors Driving Risk Premiums in Forward Contracts for Kansas Wheat
Mykel Taylor, Glynn Tonsor, and Kevin Dhuyvetter
Year: 2013
 

Abstract

Forward contracts are a risk management tool used by farmers to eliminate adverse price and basis movements prior to harvest. Elevators offering these forward contracts will offset their risk exposure by hedging their position in the futures market. However, the elevators are still exposed to basis risk and will, in turn, charge a premium to the farmers as compensation. Since 2007, basis volatility for hard red wheat in Kansas has increased, causing greater risk exposure for elevators offering forward contracts. The result has been an increase in average risk premiums of $0.06 to $0.10 per bushel. The primary factors driving this increase in the risk premium are basis and futures volatility, basis forecasting errors by elevators, and elevator- and time-specific fixed effects. The impact of this study is an increase in information for farmers on the relative costs of decreasing their basis risk exposure in a more volatile market.

 
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Have Farmers Lost Confidence in Futures Markets?
Mark Welch, Rob Hogan, Emmy Williams, John Robinson, David Anderson, Mark Waller, Stan Bevers, Steve Amosson, Dean McCorkle, and Jackie Smith
Year: 2013
 

Abstract

Since 2007, the environment for trading futures contracts has changed significantly. In late 2012 graduates of the Texas A&M AgriLife Extension Master Marketer program were surveyed to assess the degree to which the changing climate of futures and options trading is impacting their confidence in futures markets and their perception of their ability to implement price risk management strategies.

 
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How Do Producers Decide the “Right” Moment to Price Their Crop? An Investigation in the Canadian Wheat Market
Fabio Mattos and Stefanie Fryza
Year: 2013
 

Abstract

This research investigated the timing of marketing decisions in the Canadian wheat market. Cox proportional hazard models were estimated to explore how the timing of producers’ decisions were affected by market-based variable, which included an indicator showing whether current prices were above producers’ benchmark on a given day, 10-day average spread between current prices and producers’ benchmark, 10-day price trend and price volatility over 10 days. Marketing data for 17,338 producers who executed 59,184 transactions between 2003/04 and 2008/09 were used in the analysis. Overall results indicate that all variables affected timing decisions in producers’ marketing choices. However, the signs of the estimated coefficients tended to vary across contracts and years, suggesting that producers could change their pricing behavior over time and response to the covariates could also depend on characteristics of the contracts and how they relate to producers’ marketing strategies.

 
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Risk Premiums and Forward Basis: Evidence from the Soybean Oil Market
Karen E. Lewis, Mark R. Manfredo, Ira Altman, and Dwight R. Sanders
Year: 2013
 

Abstract

Soybean oil is a primary ingredient in a number of food products, and is also one of the primary oils used in the production of biodiesel. Thus the price volatility of soybean oil represents a major input price risk to food and energy companies. Forward pricing is often extended to end-users by soybean oil processors where the forward price quote is a function of futures price and basis. If the end-user locks in the basis component, the processor assumes the risk of any basis fluctuations. This research examines if soybean oil processors extract a premium for assuming this risk. Using forward basis quotes and realized basis values for soybean oil provided by The Trade News Service, Inc., it was found that soybean oil processors do not charge an embedded cost for their forward pricing services. Furthermore, the results suggest that the absence of a statistically significant embedded cost may be due to the inability of soybean oil processors to adequately forecast soybean oil basis levels.

 
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The Quality of Price Discovery Under Electronic Trading: The Case of Cotton Futures
Joseph P. Janzen, Aaron D. Smith, and Colin A. Carter
Year: 2013
 

Abstract

We estimate the effect of electronic trade on the quality of price discovery in the Intercontinental Exchange cotton futures market. Between 2006 and 2009, this market transtioned from floor-only trade to parallel floor and electronic trade and then to electronic-only trade. We use a random-walk decomposition to separate intraday variation in cotton prices into two components: one related to information about market fundamentals and one a “pricing error” related to market frictions such as the cost of liquidity provision and the transient response of prices to trades. We find that on a typical day during the electronic-only period, the standard deviation of the pricing error is half what it was on a typical day during the floor-only period. This drop reflects a substantial improvement in average market quality, much of which is associated with an increase in the number of trades per day. We report three additional findings: (i) market quality was significantly more volatile during the electronic trading period than the prior periods meaning that there were more days with large deviations from average market quality, (ii) market quality was poor immediately following the closure of the floor and (iii) market quality was better on days when public information was released in the form of USDA crop reports but worse on days where prices change by the maximum imposed by the exchange.

 
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A Nonparametric Search for Information Effects from USDA Reports
Jeffrey H. Dorfman and Berna Karali
Year: 2013
 

Abstract

The question of report value has been unsettled in the literature with results varying somewhat across studies and across reports. We employ two nonparametric tests to investigate the potential information value of USDA crop and livestock reports. If the daily returns on futures contracts differ on days with report releases when compared to non-announcement days for a sizeable number of commodities, we consider the report to contain valuable information. Results indicate value in five of the USDA reports investigated, with six other reports showing little or no information value in the markets examined. Most of our results confirm and add robustness to earlier results, but there are some differences both for certain reports and certain commodities.

 
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Revisiting the Determinants of Futures Contracts: The Curious Case of Distillers' Dried Grains
Anton Bekkerman and Hernan A. Tejeda
Year: 2013
 

Abstract

A futures market for distillers' dried grains (DDGs) was introduced on the Chicago Mercantile Exchange in early 2010, but became inactive only four months after its inception. While many new futures contracts do not develop into high-volume traders, significant interest from DDG cash market participants seemed to indicate that this contract could be successful. This study determines whether factors found in the literature to affect the success of futures contracts may have predicted the ineffectiveness of the DDG contract. We also test the impacts of market participants and the activeness of supporting futures markets, and use the empirical to determine whether the lack of activity in the ethanol futures market may have contributed to the ineffectiveness of the DDG contract. Estimation results indicate that while the existing literature would have predicted a high likelihood of success for a DDG futures contract, accounting for the inactiveness of the ethanol futures market led to the opposite conclusion.

 
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Measuring Asymmetric Price Transmission in the U.S. Hog/Pork Markets: A Dynamic Conditional Copula Approach
Feng Qiu and Barry K. Goodwin
Year: 2013
 

Abstract

This paper introduces the application of copula models to the empirical study of price transmission, with an empirical application to the U.S. hog/pork markets. Our copula approach corrects the potential bias in estimation that results from ignoring the volatility by modeling the marginal distribution of price changes through GARCH models. We also develop and apply a flexible time-varying copula framework to estimate dynamic transmission coefficients /elasticities. The model results confirm the existence of time-varying and asymmetric behaviour in price co-movements between the farm and retail markets. Positive upper and zero lower tail dependences provide evidence that big increases in farm prices are matched at the retail level whereas negative shocks at the farm level are less likely to be passed on to consumers. The application of copula techniques provides multiple, useful extension and generalizations of conventional approaches for modeling asymmetric transmissions processes on the degree of market integration and its response to price shocks under the extreme market conditions.

 
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How Much Would It Be Worth to Know the WASDE Report In Advance?
Trent T. Milacek and B. Wade Brorsen
Year: 2013
 

Abstract

Past research has shown that prices move in response to WASDE reports, but have only looked at price movements right before and right after the reports. This research seeks to determine the profitability of trading based on knowing the next WASDE report at the time of the current report. The research should help traders evaluate investments in efforts to predict the report. First, a trade and hold model is used to determine the profits of trading based on whether ending stocks will be up or down in the next WASDE report. Second, a price forecast model using an ending stocks regression is used to forecast price at the next WASDE report release. The intercept of the model is calibrated so that the model predicts the current price without error; the slope is based on report data from no more than the last two years of data. Using the forecasted price, the position of the trading model’s profit calculation can change daily based on where the closing price of the commodity is in relation to the price prediction. Profits were averaged on a days-til-report, monthly, and yearly basis. Both models were profitable and the most profitable day to trade was the report release day. However, the trade and hold model outperformed the variable position model which suggests more work is needed to increase the forecasting power of this model. This might be accomplished by using additional years of data or by a form of Bayesian smoothing to improve the forecasts.

 
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Asymmetric Price Transmission in the U.S. Beef Market: New Evidence from New Data
Veronica F. Pozo, Ted C. Schroeder and Lance J. Bachmeier
Year: 2013
 

Abstract

We examine price transmissions among farm, wholesale and retail U.S. beef markets using two types of retail level price data, one collected by the Bureau of Labor Statistics (BLS) and the other one collected at the point of sale using electronic scanners. Although some evidence suggests that BLS prices are bias (do not account for volume sales and discounted prices), we find no evidence of asymmetric price transmissions in the response of retail prices to changes in upstream prices. Our findings have important implications for the U.S. beef market efficiency. Since retailer price adjustments to farm and wholesale price changes are symmetric, the U.S. beef market is not as inefficient as found in previous studies.

 
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Bubbles in Grain Futures Markets: When are They Most Likely to Occur?
Xiaoli L. Etienne, Scott H. Irwin, and Philip Garcia
Year: 2013
 

Abstract

Unprecedented changes in commodity prices since 2004 have had worldwide repercussions, often acting as a destabilizing economic and political influence. In this paper, we use a recently developed multiple bubble testing procedures to detect and date-stamp bubbles in corn, soybean, and wheat futures markets. To account for conditional heteroskedasticity and small sample bias, inferences are derived using a recursive wild bootstrap procedure. We find that the markets experienced price explosiveness about 2% of the time. Using a logit model which accounts for bias due to the rare occurrence of an event, we find that bubbles are more likely to occur in the presence of large aggregate global demand, low stocks to use ratios, and a weak US dollar. While commodity index traders had no effect on the probability of an explosive episode, speculative activity exceeding the minimum level required to absorb hedging activities as measured by the Working’s T reduces considerably the probability of a bubble.

 
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Do Roll Returns Really Exist? An Analysis of the S&P GSCI
Paul E. Peterson
Year: 2013
 

Abstract

Roll returns for the S&P GSCI commodity index are analyzed using index calculation procedures for the S&P 500 stock market index. S&P GSCI daily index values are calculated and validated against the official index values for the five-year period January 2007-December 2011. Index values are then calculated using divisor adjustment methods for the S&P 500. Roll returns are found to be caused by the unique index calculation procedures used by the S&P GSCI during roll periods.

 
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Smoothing in USDA’s Commodity Forecasts
Olga Isengildina, Stephen MacDonald, Ran Xie and Julia Sharp
Year: 2013
 

Abstract

This study investigates the rationality of monthly revisions in annual forecasts of supply, demand, and price for U.S. corn, cotton, soybeans, and wheat, published in the World Agricultural Supply and Demand Estimates over 1984/85 through 2011/12. The findings indicate that USDA’s forecast revisions are not independent across months, and that forecasts are typically smoothed. Adjustment for smoothing in a subset of forecasts (2002/03 – 2011/12) showed weak results: marginal improvements in accuracy were limited to wheat production and cotton production and domestic use while deterioration in accuracy was observed in all other cases. Smoothing coefficients were highly unstable over time. Case studies for corn focused on correction for a structural break and the impact of forecast size and direction, but did not lead to improvements in accuracy. Case studies for October revisions of soybean production forecasts suggest that ten year rolling estimation and correcting for outliers using leverage may help improve accuracy in the adjusted forecasts.

 
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The dynamics of the Ukrainian farm wheat price volatility: Evidence from a dynamic conditional correlation GARCH model development
Linde Gotz, Kateryna Goychuk, Thomas Glauben and William H. Meyers
Year: 2013
 

Abstract

This paper investigates the development of price volatility in the Ukrainian wheat market from 2005 till 2012 within a dynamic conditional correlation GARCH model. The results indicate that the export controls in Ukraine have not significantly reduced price volatility on the domestic wheat market. On the contrary, our findings suggest that the multiple and unpredictable interference of the Ukrainian government on the wheat export market has substantially increased market uncertainty which led to pronounced additional price volatility in the market.

 
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Testing the Effectiveness of Using a Corn Call or a Feeder Cattle Put for Feeder Cattle Price Protection
Hernan A. Tejeda and Dillon M. Feuz
Year: 2013
 

Abstract

This paper studies the effect, from an options market perspective, that the substantial increase in corn prices and volatility has had on the feeder cattle market. An empirical study is conducted to compare the effectiveness of a feeder cattle operator using either a corn ‘call’ or a feeder cattle ‘put’ to mitigate the margin risk from price volatility. Specifically, the operator sets feeder cattle price conditions at different periods of the year and applies either option strategy. The period studied is from 2003 to 2012. Results are of higher margin variability for the latter years as anticipated – where corn faced much increased demand. In general, operations using a corn call resulted in a bit higher margin variability than operations using a feeder cattle put for most of the years considered. This is not as anticipated, given the broader and more diversified market for corn options – reflected in the much larger number of ‘at the money’ or nearest ‘in the money’ transactions at expiration - in comparison to the thinner feeder cattle options market. However, this may be due to the much fewer number of ‘at the money’ or nearest ‘in the money’ transactions for feeder cattle puts (i.e. many cases having no puts traded or be all ‘out of the money’), which results in less margin variability. Another finding is that operators who set price conditions in May (instead of July or October) generally through a corn call, did not experience substantial increase of margin variability - especially during a very volatile 2009 year. This may respond to mostly circumventing changing conditions in the corn market during summer and fall season, with the arrival of new crop information.

 
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Actuarially Fair or Foul? Asymmetric Information Problems in Dairy Margin Insurance
John Newton, Cameron S. Thraen, and Marin Bozic
Year: 2013
 

Abstract

There is a wide consensus in the academic literature that asymmetric information in the form of adverse selection and moral hazard has resulted in sizable financial outlays for governmentsponsored crop insurance programs - ultimately becoming a costly means of transferring risk from farmers to the government. In this analysis we combine simulation and structural modeling techniques to forecast dairy income-over-feed-cost margins and show how asymmetric information problems may drive industry consolidation, production growth, and unforeseen program costs for a recently proposed government-sponsored dairy producer margin insurance program. We conclude by presenting second-best solutions in contract design to the insurance problems of moral hazard and adverse selection.

 
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Pricing and Hedging Calendar Spread Options on Agricultural Grain Commodities
Adam Schmitz, Zhiguang Wang, and Jung-Han Kimn
Year: 2013
 

Abstract

The calendar spread options (CSOs) on agricultural commodities, most notably corn, soybeans and wheat, allow market participants to hedge the roll-over risk of futures contracts. Despite the interest from agricultural businesses, there is lack of both theoretical and empirical research on pricing and hedging performances of CSOs. We propose to price and hedge CSOs under geometric Brownian motion (GBM) and stochastic volatility (SV) models. We estimate the model parameters by using implied state-generalized method of moments (IS-GMM) and evaluate the in-sample and out- of-sample pricing and hedging performances. We find that the average pricing errors of the SV model are 0.79% for corn, 0.75% for soybeans and 1.2% for wheat; the pricing and hedging performance of the SV model are mostly superior to the benchmark GBM model, both in and out of sample, with only one exception where the out-of-sample hedging error for the GBM model for market makers is slightly better than the SV model.

 
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Information Transmission between Livestock Futures and Expert Price Forecasts
Jason Franken, Philip Garcia, Scott H. Irwin, and Xiaoli Etienne
Year: 2013
 

Abstract

We evaluate dynamic interaction between four expert forecasts, futures prices, and realized cash hog prices. Lag structures of three variable vector autoregression indicate dynamic interaction among futures and cash markets and that past forecasts impact cash prices. Causal analysis of model residuals reveals contemporaneous causation of cash prices by futures prices and by some forecasts, and in all cases indicates causal structures consistent with the chronological ordering of prior day futures, subsequent forecasts, and cash prices realized one quarter later. Error decompositions following this ordering indicate expert forecasts are somewhat more important to futures and cash markets than previously believed.

 
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Price Density Forecasts in the U.S. Hog Market: Composite Procedures
Andres Trujillo-Barrera, Philip Garcia, and Mindy Mallory
Year: 2013
 

Abstract

We develop and evaluate quarterly out-of-sample individual and composite density forecasts for U.S. hog prices using data from 1975.I to 2010.IV. Individual forecasts are generated from time series models and the implied distribution of USDA outlook forecasts. Composite density forecasts are constructed using linear and logarithmic combinations, and several straightforward weighting schemes. Density forecasts are evaluated on goodness of fit (calibration) and predictive accuracy (sharpness). Logarithmic combinations using equal and mean square error weights outperform all individual density forecasts and all linear combinations. Comparison of the USDA outlook forecasts to the best logarithmic composite demonstrates the consistent superiority of the composite procedure, and identifies the potential to provide hog producers and market participants with accurate expected price probability distributions that can facilitate decision making.

 
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Price Discovery in the U.S. Fed Cattle Market
Kishore Joseph, Philip Garcia, and Paul E. Peterson
Year: 2013
 

Abstract

We study price discovery in the U.S. fed cattle market, examining the interaction among weekly live cattle futures, negotiated cash fed cattle, and boxed beef cutout prices. Extensive testing and innovation accounting based on directed acyclic graphs of error-correction resid- uals indicates that the futures price continues as the dominant source of information in the fed cattle market. While the cash cattle price has a strong predictive in uence on the boxed beef price, the boxed beef price plays only a marginal role in price discovery.

 
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Have Extended Trading Hours Made Agricultural Commodity Markets More Risky?
Nathan S. Kauffman
Year: 2013
 

Abstract

In May 2012, the Chicago Mercantile Exchange extended trading hours for several agricultural commodities, including corn. Since then, trading during the release of a key U.S. Department of Agriculture report known as the World Agricultural Supply and Demand Estimate has been possible. Some concerns have been expressed that trading through the release of important market information might generate higher price volatility in agricultural commodity markets. The purpose of this paper is to examine the effect of extended trading hours on intraday price volatility in corn futures markets. The results suggest that trading during the information releases in 2012 has led to brief periods of excessive volatility immediately after the reports were released, but the higher volatility did not persist much beyond 60 minutes. The paper also highlights the role of higher liquidity in absorbing potential market shocks.

 
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How Could We Have Been So Wrong? The Puzzle of Disappointing Returns to Commodity Index Investments
Scott Main, Scott H. Irwin, Dwight R. Sanders, and Aaron Smith
Year: 2013
 

Abstract

Investments into commodity-linked investments have grown considerably since their popularity exploded—along with commodity prices—in 2006 through 2008. Numerous individuals and institutions have embraced alternative investments for their purported diversification properties and “equity-like” returns; yet, real-time performance has been disappointing. As an example, Morningstar reports that the iShares S&P GSCI Commodity Index Trust lost an annualized 9.1% in the 5 years ending December 31, 2012. The puzzling aspect of this poor performance is that it occurred at a time when the overall trend in commodity prices was sharply upward. In this paper, we explicitly show that the disappointing returns for commodity index investments were not directly caused by the futures market structure, i.e., “contango.” Rather, the implicit—and unavoidable—cost of holding physical commodities is inherent in futures prices and thereby creates a necessary performance “gap” between the returns to long-only futures positions and observed spot market prices.

 
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Impacts of Crop Conditions Reports on National and Local Wheat Markets
Ryan Bain and T. Randall Fortenbery
Year: 2013
 

Abstract

The USDA releases crop condition reports that contain crop progress and growing conditions estimates for various crops including corn, soybeans, and winter wheat. Previous work has investigated national market impacts from various USDA reports. However, this work is new because it investigates crop conditions report releases for price impacts on winter wheat at both the local and national level. The primary tools for analysis are parametric tests and the nonparametric Savage scores test. The results suggest that crop conditions reports may be anticipated by the futures markets prior to release, with similar though non-significant impacts felt in local cash markets. These results contrast significantly with those found in similar studies for corn and soybeans.

 
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