Price Discovery in U.S. and Foreign Commodity Futures Markets: The Brazilian Soybean Example

Trader direct access to the order matching systems on United States and foreign commodity futures markets reduces or eliminates the cost of changing trading venues. The Dodd-Frank Act recognizes that price discovery could now more readily shift to foreign futures markets if futures market regulations in the United States were more stringent than those for foreign futures markets. Price discovery is the incorporation of market fundamentals into price. It is done by traders that make trades based on informed judgments about market fundamentals The Act does not provide guidance on how to measure price discovery. We examine the use of the Gonzalo- Granger Decomposition to measure the relative soybean price discovery contribution of the Chicago Mercantile Exchange and the Brazilian Mercantile and Futures Exchange. Daily opening and closing soybeans prices from the two exchanges are used in the examination. We provide evidence that there is exchange of soybean price fundamentals between the two exchanges after the beginning of direct trader access between the two exchanges. Simultaneous soybean transaction prices are required for making reliable estimates of the relative contribution of each futures exchange to soybean price discovery.