Graduate Thesis Or Dissertation
 

Temporal price relationships in cash forward and futures markets for white wheat

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  • Forward pricing is a marketing tool available to Pacific Northwest white wheat growers for reducing price risk. The cash forward contract is the traditional pricing mechanism used for this purpose. In September 1984, another option for forward pricing was made available through the introduction of a new futures market for white wheat traded at the Minneapolis Grain Exchange. This research analyzes price behavior in these two forward pricing markets in 1985 from two perspectives. Using the efficient market hypothesis, this study first evaluates the temporal price relationships in each market. Second, the research measures the relationships between the two markets in light of the concept of causality. Prices in an efficient market should reflect all available information. In this research, the weak form test for the efficient market hypothesis, known as the random walk model, assessed pricing efficiency in both markets. The random walk hypothesis holds when successive price changes are independent. Based on the evidence of statistically insignificant autocorrelation coefficients, the futures market was efficient under the random walk hypothesis. There were no systematic patterns in the price movements. In contrast, in all delivery time periods except December, the cash forward market exhibited nonrandomness in price changes. The analysis on the relationship between the two markets was made using Granger's definition of causality. Using ordinary least squares regression, this research evaluated the causal link between the two price series with two parallel tests, the direct Granger's and the Sims'. Strong causality ran from futures prices (FT) to cash forward prices (CF) in the September harvest time delivery period. Some causality from FT to CF lingered into the December and March storage month delivery periods. There were no causal relationships in other delivery periods except a feedback from CF to FT in the March period. Despite low trading activity, futures prices were found to represent an efficient market. Thus, they accurately reflected market signals concerning the supply of, and demand for, white wheat. On the contrary, nonrandomness found in cash forward prices suggests inefficiency in this market. The causality found from FT to CF is consistent with the expectation. Farm level forward pricing activity is greatest for harvest (August/September) and immediate post-harvest delivery months. This causes buyers of cash forward contracts to pursue price risk management. Thus, futures prices were used as references, or hedges, in setting cash forward prices in these delivery time periods. The irregular causality pattern between the two markets implies a changing market environment, possibly caused by differing price determination processes over time. Serial dependence in cash forward prices may be providing misleading signals about the white wheat market. However, the weak form test used here could not estimate the magnitude of the inefficiency.
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