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Price Non-Convergence in Commodities: A Case Study of the Wheat Conundrum

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  • Sophie van Huellen

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    (Department of Economics, SOAS, University of London, UK)

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    Abstract

    The close relationship between commodity future and cash prices is critical for the effectiveness of risk management and the functioning of price discovery. However, in recent years, commodity futures prices, across the board, have appeared increasingly detached from prices on physical markets. This paper argues that while various factors, identified in previous literature, which introduced limits to arbitrage have facilitated non-convergence, the actual extent of non-convergence in these markets is caused by essential differences in the mechanisms of price formation on physical and derivative markets. With reference to the particular case of the CBOT wheat market, the paper shows that the size of the spread between futures and cash prices can be theoretically and empirically linked to the increasing inflow of financial investment into commodity futures markets.

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    Bibliographic Info

    Paper provided by Department of Economics, SOAS, University of London, UK in its series Working Papers with number 185.

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    Length: 31 pages
    Date of creation: Oct 2013
    Date of revision:
    Handle: RePEc:soa:wpaper:185

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    Keywords: commodity futures; commodity price formation; financialisation; nonconvergence;

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    1. Crain, Susan J & Lee, Jae Ha, 1996. " Volatility in Wheat Spot and Futures Markets, 1950-1993: Government Farm Programs, Seasonality, and Causality," Journal of Finance, American Finance Association, vol. 51(1), pages 325-43, March.
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    16. Ke Tang & Wei Xiong, 2010. "Index Investment and Financialization of Commodities," NBER Working Papers 16385, National Bureau of Economic Research, Inc.
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