Performance Evaluation of Agricultural Commodity Futures Market in India

(ProQuest: ... denotes formulae omitted.)IntroductionIn recent years, there has been a considerable increase in overall turnover across the three major national commodity exchanges, from 34,84,485 cr in 2006 to 94,94,725 cr in 2010 (Government of India, 2011). The balancing between price discovery and issues of speculation is a major challenge for policy makers, particularly in the emerging markets, so as to ensure fair market conditions. The anomalies in price discovery have given rise to ambiguous prices for farmers and undue advantages to arbitragers and speculators (Thomas, 2003). There is thus an ongoing debate: high speculation leading to volatility in prices on one side and rewarding farmers with better price discovery on the other. This paper aims to evaluate the efficiency of agricultural commodity futures markets in India. The issue assumes significance as the academia has confined itself largely to the developed markets to evaluate the performance of futures market. The study uses models of financial econometrics to identify the markets where price discovery occurs for a range of commodities.Literature ReviewLiterature on the relationship between commodity futures and spot markets varies with respect to the developed and developing countries. Internationally, the futures market is an unbiased estimator of spot prices, benefitting farmers in crop decisions and profitability. Any intervention by the regulator is only detrimental to spot prices, observes Cox (1976). The studies in India differ in findings. Singh (2001) concludes that the efficiency is not a standard characteristic of futures market and it varies with respect to maturity period of the contracts. Thus the 'Maturity Effect' plays a key role in determining the performance of futures markets. Thomas (2003) studies the Indian castor seed market and finds that the castor futures market leads castor spot market in factoring information in advance, except in India's harvesting season of March. Verma and Vijaya (2010) prove that pepper and wheat markets show an increase in volatility with decrease in maturity period. Fry et al. (2011) use estimates such as Vector Auto-Regression (VAR) and Granger Causality Test to show that the direction of causality between futures and spot market is not uniform across commodities.Carter (1999) contends that a more fundamental issue such as low participation by farmers in hedging needs to be given priority in policy decisions. Westerhoff(2003) further adds that timely intervention by the regulator can improve the efficiency of futures market. Jacks (2007) shows that the argument of speculation is a result of antagonism against the futures market and Santos (2006), in his study on the US grain market, concludes that futures market has only reduced speculation by increasing the relative sensitivities of producers and speculators by adding the dimension of rational expectations and decisions. A committee set up under the chairmanship of Abhijit Sen (Government of India, 2008) found that the futures market aids in price discovery of spot prices and finds no proof of excessive speculation. Westerhoffand Wielang (2010) take a nonlinear behavior-cobweb model to emphasize the need for healthy speculation, concluding that the structure and strength of the market determines the proportion of healthiness in speculation. Dasgupta et al. (2011) study the wheat market to model for effective intervention, policy making and forecasting. They conclude that bans in futures market are essential to balance the international and domestic price anomalies.French (1986) argues that the occurrence of simultaneous price discovery in spot and futures market negates advantages (if any) of one market over the other. Stein (1961) and Pindyck (2001) further talk about simultaneous price discovery in futures and spot market with convenience yield being a major factor. Storable commodities and their corresponding carrying costs, along with the perishable characteristics of the product are considered vital by Carter and Mahopatra (2008) for the hog futures market. …