Intertemporal Price Relationships of Storable and Nonstorable Commodities: Theory and Application
Naik, Gopal
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https://hdl.handle.net/2142/69888
Description
Title
Intertemporal Price Relationships of Storable and Nonstorable Commodities: Theory and Application
Author(s)
Naik, Gopal
Issue Date
1988
Doctoral Committee Chair(s)
Leuthold, Raymond M.
Department of Study
Agricultural Economics
Discipline
Agricultural Economics
Degree Granting Institution
University of Illinois at Urbana-Champaign
Degree Name
Ph.D.
Degree Level
Dissertation
Keyword(s)
Economics, Agricultural
Abstract
Major disagreements remain unresolved with the theories of Keynes and Working regarding intertemporal price relationships, hence better explanation is needed. Keynes' theory of normal backwardation suggests that a risk premium, which a hedger pays to transfer risk, exists in futures markets. However, Working's theory of price of storage suggests that hedgers participate in the futures market in pursuit of profit and the arbitrage possibilities eliminate any bias in the futures price.
The primary objective of this study is to establish theoretically and to test empirically the relationships between cash and futures prices for storable and nonstorable commodities. A general theory of intertemporal price relationships for storable commodities is derived. According to this theory, basis consists of basis risk premium, adjusted speculation and expected maturity basis apart from cost of storage, opportunity cost and convenience yield. Keynes' risk premium and Working's carrying charge theories are special cases of this theory. Empirical results suggest that in the case of corn, the basis includes a risk premium, a speculative component and expected maturity basis.
In the case of nonstorable commodities, theoretical results are derived assuming that there exists some time period during which the producer is flexible to make marketing decisions. The results show that if the time between successive production streams is shorter than the marketing decision period, then cash and futures prices are intertemporally related. The difference between the cash and nearby futures prices is a function of the sum of the cost of maintaining the animal, opportunity cost, expected maturity basis, basis risk premium and adjusted speculation. The two-period ahead futures price and current cash price are related through feed price and through carryover effect of the animals from one period to another.
The results indicate that there exists a risk premium, a speculative component and an expected maturity basis in both cattle and hog markets. Finally, the cash and futures prices are related beyond one month. For cattle, the cash price seems to influence distant futures prices more than for hogs.
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