The investigation of destabilization effect in India’s agriculture commodity futures market

Purpose - – This paper aims to examine the destabilization effect in the case of India’s agricultural commodity market for the sample period of 01 January 2009 to 31 May 2013. Design/methodology/approach - – The daily data of eight agricultural commodities traded on the National Commodity & Derivatives Exchange, viz., barley, castor seed, chana (chickpea), chilli, potato, pepper, refined soya and soybean, have been used in this study. At the first stage of the empirical analysis, the study estimates the time-varying spot market volatility by using the exponential generalized autoregressive conditional heteroscedasticity model and applies three different high and band-pass filters, viz., the two-sided linear band-pass filter by Hodrick and Prescott (1997), the fixed-length symmetric band-pass filter by Baxter and King (1999) and the asymmetric band-pass filter by Christiano and Fitzgerald (2003), to calculate the unexpected liquidity of sample commodities. At the second stage of the empirical analysis, the study applies linear Granger causality and recently developed non-linear causality given by Diks and Panchenko (2006) to examine the cause and effect between time-varying volatility of spot market and futures market liquidity of sample commodities. Findings - – The linear and non-linear causality results suggest the destabilizing effect of commodity futures on the underlying spot market for chana, chilli and pepper. The empirical findings are in contrast with the recommendations of Abhijit Sen’s committee and provide important direction for further policy research. Research limitations/implications - – The study has a limitation in that it is based on the daily data. The use of intra-day data would have been more suitable for such type of analysis. Practical implications - – The study has strong policy implications from a financial policy perspective, as there is already disagreement among researchers and policy makers with regard to the functioning of commodity derivatives markets in India. There have been many occasions when commodity market regulators have to undertake decisions of suspension of trading of many commodities. The study also provides new directions of policy research with regards to the restructuring of the commodity derivatives market in India. Social implications - – The findings of this study may further help the regulators and policy makers to undertake decisions about how to provide an alternative platform for farmers to sell their agricultural produce more efficiently. This will certainly have some impact on the socioeconomic set-up of the country, as India is primarily an agriculture-dominated country. Originality/value - – So far not many studies have investigated the destabilization hypothesis in the case of emerging markets. This study is a novel attempt to fill the gap. In the case of emerging markets and especially in the case of India’s commodity derivatives market, this is the first study that examines the destabilization hypothesis in the case of India by applying new methods of high and band-pass filters and non-linear causality.