|Abstract or Summary
- 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