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Non-Convergence in Domestic Commodity Futures Markets: Causes, Consequences, and Remedies

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Author Info

  • Adjemian, Michael K.
  • Garcia, Philip
  • Irwin, Scott
  • Smith, Aaron

Abstract

During most of 2005-10, the price of expiring U.S. corn, soybeans, and wheat futures contracts settled much higher than corresponding delivery market cash prices. Because futures contracts at expiration are commonly thought to be equivalent to cash grain, this commodity price non-convergence appeared inconsistent with the law of one price. In addition, sustained non-convergence concerns market participants, exchanges, and policymakers because it can make hedging less effective, send confusing signals to the market, threaten the viability of a contract, and ultimately lead to a misallocation of agricultural resources. This report summarizes prominent theories that have been offered to explain non-convergence, including a new model that explains how the structure of a competitive delivery market can generate a positive expiring basis. The data support this delivery market theory over alternative explanations. Finally, we discuss various policy levers that have been offered to address non-convergence, as well as their likely impacts.

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Bibliographic Info

Paper provided by United States Department of Agriculture, Economic Research Service in its series Economic Information Bulletin with number 155381.

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Date of creation: Aug 2013
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Handle: RePEc:ags:uersib:155381

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Related research

Keywords: commodity futures; index funds; grains; non-convergence; price discovery; risk management; speculation; storage; Crop Production/Industries; Farm Management; Resource /Energy Economics and Policy;

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References

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  1. Chang, Eric C, 1985. " Returns to Speculators and the Theory of Normal Backwardation," Journal of Finance, American Finance Association, American Finance Association, vol. 40(1), pages 193-208, March.
  2. Frank, Julieta & Garcia, Philip, 2005. "Time-Varying Risk Premium or Informational Inefficiency? Further Evidence in Agricultural Futures Markets," 2005 Conference, April 18-19, 2005, St. Louis, Missouri, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management 19051, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
  3. Hartzmark, Michael L, 1987. "Returns to Individual Traders of Futures: Aggregate Results," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 95(6), pages 1292-1306, December.
  4. Hartzmark, Michael L, 1991. "Luck versus Forecast Ability: Determinants of Trader Performance in Futures Markets," The Journal of Business, University of Chicago Press, vol. 64(1), pages 49-74, January.
  5. Peck, Anne E. & Williams, Jeffrey C., 1991. "Deliveries on Chicago Board of Trade Wheat, Corn, and Soybean Futures Contracts, 1964/65-1988/89," Food Research Institute Studies, Stanford University, Food Research Institute, Stanford University, Food Research Institute, issue 02.
  6. Bahattin Buyuksahin & Jeffrey H. Harris, 2011. "Do Speculators Drive Crude Oil Futures Prices?," The Energy Journal, International Association for Energy Economics, International Association for Energy Economics, vol. 0(Number 2), pages 167-202.
  7. Pirrong, Craig, 2001. "Manipulation of Cash-Settled Futures Contracts," The Journal of Business, University of Chicago Press, vol. 74(2), pages 221-44, April.
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Cited by:
  1. Adjemian, Michael & Janzen, Joseph & Carter, Colin & Smith, Aaron, 2014. "Deconstructing Wheat Price Spikes: A Model of Supply and Demand, Financial Speculation, and Commodity Price Comovement," Economic Research Report, United States Department of Agriculture, Economic Research Service 167369, United States Department of Agriculture, Economic Research Service.

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