Cheddar Cheese and Fluid Milk Cointegration among Cash and Futures Prices: The Evidence for a Long-term Equilibrium Relationship

In the early 1990's, after four decades of relying on government mandated minimum price supports and public stockholding to achieve price risk management, the United States dairy industry is undertaking a shift to a market clearing equilibrium system. A significant component of this new structure is the development of an operational futures market for selected milk and dairy products. In June of 1993 the Coffee, Sugar, & Cocoa Exchange introduced contracts on nonfat dry milk and cheddar cheese. In December of 1995 the CSCE introduced a contract on fluid milk and this was followed in January 1996 by a similar fluid milk contract trading on the Chicago Mercantile Exchange. This paper examines the extent to which a long-run equilibrium relationship has been established between the cheese and fluid milk futures markets and their cash market counterparts. The existence of a long-run equilibrium is a necessary condition for effective hedging opportunities. Using the time series concept of cointegrated series we concluded that the data support an equilibrium relationship in the cheese markets but provide no support for an equilibrium relationship in the fluid milk market.