The Emerging Futures Market for Cheddar Cheese: A Mechanism for Stability or Increased Spot-Price Volatility?

In the early 1990's, after four decades of relying on government authorized minimum price supports and the required public stockholding necessary to achieve price risk management, the United States dairy industry began a journey toward a shift to a market clearing equilibrium system. In this new era the forces of supply and demand determine product prices and changes in those prices. With this market clearing system comes an increase in the volatility of product prices and the risk associated with this volatility. A potentially important 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 (CSCE) introduced a contract on cheddar cheese. The Chicago Mercantile Exchange began trading a cheese contract in October 1997. Today there are contracts covering cheese, butter, nonfat dry milk and raw milk. As the production of cheese represents over one-third of the use of raw milk in the United States, this contract has the potential of serving as an important price risk management tool. An important question to be addressed is whether or not the speculative trading activity on these contracts will increase or decrease spot price volatility. This study investigates this question for the CSCE cash cheese market. The results suggest that the trading on the futures market for cheddar cheese has not increased the cheese spot market price volatility and therefore provides additional support for the continued development of the futures market as a price risk management tool by the dairy industry.