Price Transmission across Commodity Markets: Physical to Futures

Primary commodity prices are generally determined in dual markets: a physical--spot market dominated by supplier--producers and a forward--futures market where consumers, producers and speculators interact. While the futures market operates on an almost continuous basis, the spot market only opens in predetermined short periods of time over which the state of supply and demand is revealed. This poses a challenge for the question of price dynamics: which market leads/follows and where does price discovery occur? We perform an empirical analysis using spot and futures coffee prices and find that most price information originates from the futures markets. Shocks to the spot price are quickly integrated into the market prices, with the effect of the shock quickly dying out or a new equilibrium being attained. A shock to the futures price almost always leads to a permanent change in prices leading to a new equilibrium.