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

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  • 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.

Suggested Citation

  • Adjemian, Michael K. & Garcia, Philip & Irwin, Scott & Smith, Aaron, 2013. "Non-Convergence in Domestic Commodity Futures Markets: Causes, Consequences, and Remedies," Economic Information Bulletin 155381, United States Department of Agriculture, Economic Research Service.
  • Handle: RePEc:ags:uersib:155381
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    References listed on IDEAS

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    1. J. Frank & P. Garcia, 2009. "Time-varying risk premium: further evidence in agricultural futures markets," Applied Economics, Taylor & Francis Journals, vol. 41(6), pages 715-725.
    2. Bahattin Buyuksahin & Jeffrey H. Harris, 2011. "Do Speculators Drive Crude Oil Futures Prices?," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2), pages 167-202.
    3. Hartzmark, Michael L, 1987. "Returns to Individual Traders of Futures: Aggregate Results," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1292-1306, December.
    4. Pirrong, Craig, 2001. "Manipulation of Cash-Settled Futures Contracts," The Journal of Business, University of Chicago Press, vol. 74(2), pages 221-244, April.
    5. 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.
    6. Chang, Eric C, 1985. " Returns to Speculators and the Theory of Normal Backwardation," Journal of Finance, American Finance Association, vol. 40(1), pages 193-208, March.
    7. 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, issue 02.
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    Cited by:

    1. Domenica Tropeano, 2016. "Hedging, arbitrage and the financialization of commodities markets," Working Papers 82-2016, Macerata University, Department of Finance and Economic Sciences, revised Sep 2016.
    2. Bekkerman, Anton & Brester, Gary W. & Taylor, Mykel, 2016. "Forecasting a Moving Target: The Roles of Quality and Timing for Determining Northern U.S. Wheat Basis," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 41(1), January.
    3. Adjemian, Michael & Brorsen, B. Wade & Hahn, William & Saitone, Tina L. & Sexton, Richard J., 2016. "Thinning Markets in U.S. Agriculture," Economic Information Bulletin 232928, United States Department of Agriculture, Economic Research Service.
    4. Kevin Guo & Tim Leung, 2016. "Understanding the Non-Convergence of Agricultural Futures via Stochastic Storage Costs and Timing Options," Papers 1610.09403, arXiv.org, revised Apr 2017.
    5. Adjemian, Michael K. & Marshall, Kandice K. & Hubbs, Todd & Penn, Jerrod, 2016. "Decomposing Local Prices into Hedgeable and Unhedgeable Shocks," 2016 Annual Meeting, July 31-August 2, 2016, Boston, Massachusetts 235874, Agricultural and Applied Economics Association.
    6. Adjemian, Michael K. & Janzen, Joseph & Carter, Colin A. & Smith, Aaron, 2014. "Deconstructing Wheat Price Spikes: A Model of Supply and Demand, Financial Speculation, and Commodity Price Comovement," Economic Research Report 167369, United States Department of Agriculture, Economic Research Service.

    More about this item

    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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