21

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

ABSTRACT

The volume of commodity futures trading inIndia has increased from 20.53 trillion rupeesin 2006 to Rs.181.26 trillion rupees in 2011-12. Inspite of fast growth the commoditymarkets have gone through tumultuous timesespecially after independence. The twinfunctions of price discovery and price riskmanagement have been discussed from timeto time with conflicting opinions from varioussegments. Allegations of price volatilityshooting up with the increase in futurestrading volume have hindered the growth anddevelopment of markets thereby impacting itsstakeholders. This paper discusses the pathof futures trading in India, its significance inthe present scenario of ever increasingvolatility and how various commodity futureshave fared with respect to their role as ahedging instrument and as a means ofdiscovering the prices for transacting physicalmarket transactions. To catch up with thecountries which have hitherto achieved somematurity in derivatives trading, there is a needto strengthen research on all aspects ofcommodity markets.

Keywords: Commodity Derivatives, India,Commodity Futures, Price Discovery,Volatility.

INTRODUCTION

Prices of commodities have witnessed anunprecedented upward movement ever since1970’s with the fluctuations remaining withincertain range till the year 2000 after whichthere has been no looking back in the risingtrend except for the year of global financialcrisis in 2008. End of 2011 saw average pricesof energy and base metals in real terms, threetimes higher than those touched a decade ago.Food and raw material prices have also risen,though not to the levels reached in 1970 (IMF,2011) Figure 1. There have been manyexplanations for the phenomenal price rise.Developing BRIC countries, especially Chinahave exerted tremendous demand pressure thathas not been matched by supply resulting inprice rise. Another viewpoint is that lowinterest rates and easy liquidity conditions tosupport demand has resulted in oil priceincrease which also percolated to othercommodities (Calvo, 2008). But the majorconcern is about the increasing speculation incommodities market. Amongst otherexplanations, speculation has been triggeredby the financialization of commodities in manycountries which has forced the regulatoryauthorities and researchers to deliberate uponthe ways to minimize the impact of noisebrought about by uninformed speculation onthe prices of commodities. Implications of thisare grave not only for the producers, exporters

PRICE DISCOVERY & IMPACT ON SPOT PRICEVOLATILITY: ANECDOTES FROM INDIAN

COMMODITY FUTURES MARKET

Meenakshi Malhotra,Amity International Business School

Noida, India, Email: meenakshi383@gmail.com

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

22

Figure 1: World Commodity Prices (Source: IMF Staff Calculations)

fresh impetus for research in the area ofcommodity futures market. The World Bank(1999) notes: “market based managementinstruments, despite several limitations, offera promising alternative to traditionalstabilization schemes…”The argument is thatthe use of price risk management instrumentsallows governments to disengage from costly,distortionary and counterproductive policies.

Developments are taking place both at thenational and international front forimprovements of commodity futures market.

and traders but more for the poor in developingcountries who spend 60 to 80 percent of theirincome on food (FAO, 2008). The high pricesfor basic commodities limit the income offarmers/ small producers whereas high

volatility of prices makes it very difficult forthem to optimize the use of their income(Morgan, 2000) Therefore, there are gravehumanitarian concerns, social & economicrepercussions of this vicious problem.

Worldwide the national governments havedesigned various policies to control theseinstabilities in prices, but by and large thesepolicies have been based on intervention bythe state to artificially stabilize prices. Thesemeasures put a strain on the national resources,promote inefficiencies and arecounterproductive. In the recent past, countrieshave begun to liberalize commodity marketsand in particular commodity futures marketsare being developed. The World Bank initiatedthe use of market based instruments for dealingwith commodity price risks and this has given

23

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

At the International front The Task Force onCommodity Futures Markets (Task Force) wasformed in September 2008 by the TechnicalCommittee of IOSCO(InternationalOrganization of Securities Commissions)responding to calls for an examination of thefunctioning of certain commodity futuresmarkets from the G8 Finance Ministers in2008. It was decided that the scope of the TaskForce should go beyond oil to include othercommodity derivatives such as agricultural-based contracts. Task Force recommended thatwork on commodities markets be placed on apermanent basis within IOSCO. This wouldinclude making new recommendations forfurther work which was likely to lead toproposals to improve market transparency,anti-market abuse treatment for othercommodities markets, where necessary.3

UNCTAD in its Trade & DevelopmentReport,2011 on Post Crisis Policy Challengesin the world economy has suggested measuresto be adopted to improve the functioning ofcommodity derivatives markets because theseare eventually facilitating the risk transferneeds of the hedgers and providing pricesignals to producers & consumers.

At national level the Government of India’sWorking Group on Agricultural MarketingInfrastructure and Policy Required for Internal& External Trade for Eleventh Five-Year Plan(2007-12) saw an important role forcommodity futures exchanges as deliveringprice discovery & risk mitigation for farmers,with emphasis on the development ofelectronic spot exchanges as a mechanics forfurther extending these benefits.

Functions of Commodity Futures Market

The two most important economic functionsof futures trading are price discovery and pricerisk management. The trading activity offutures market participants viz. hedgers,

speculators and arbitrageurs help inestablishing equilibrium prices forcommodities. The prices displayed by theexchanges reflect how much the buyers arewilling to pay and how much is acceptable tothe seller for the commodity based on eachsegments’ information of the fundamentalposition of the commodity. On the basis ofprice signals emanating from the futuresmarket, production, procurement, export,marketing strategies are made. The presenceof speculators in the market enables thehedgers to transfer their price risk. As a result,farmers get assured price for their produce,exporters and importers can hedge theircommitments at remunerative prices.

Futures markets also provide support forcredit needs to small producers. The collateralvalue of inventory is enhanced if it is hedged,enabling firms to borrow on better terms.According to Gorton and Rouwenhorst (2005)commodity futures have been seen to exhibitnegative correlation with stock futures andbonds & positive correlation with inflation, sothey serve as an additional risk managementtool. They found that the average correlationbetween returns on equities and commodityfutures was a statistically significant –0.42 ifthe investments were held for 5 years. Hence,they provide stability under volatile marketconditions.

Commodity Futures in India

India was one of the first countries in the worldto adopt commodity exchanges, with itsearliest exchange dating back to the BombayCotton Trading association in 1880s. Firstorganized futures market, for various types ofcotton appeared in 1921 and subsequentlyproliferated. Regulated trading in commoditiesstarted after the enactment of Forward Contract(Regulation) Act 1952 which provided thelegal framework for organized forward trading

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

24

in the country and for recognition ofcommodity exchanges. Under this Actcommodities are notified for regulation andprohibition of forward contract. Due toconcerns regarding its effect on prices andsupply of essential commodities andspeculation in times of scarcity the marketsfor several commodities like cotton, oilseeds,bullion and jute were suspended during the1960s and 1970s. Later the Khusro Committee(June 1980) recommended reintroduction offutures trading for cotton, kapas, raw jute andin the later half of 1980 futures trading inpotatoes was resumed in Punjab & UttarPradesh.

Following the launch of economic reforms inthe early 1990s, and especially after Indiasigned the General Agreement on Trade andTariffs (GATT) to enter the World TradeOrganization (WTO), the World Bank andUNCTAD submitted a joint report to theGovernment of India recommending revivalof futures trading in farm commodities andtheir products to render trade in suchcommodities competitive in the world marketsafter the envisaged removal of trade and non-trade barriers. Also, Government of India setup Kabra Committee in 1993 to review thefutures trading for other commodities whichwere hitherto prohibited. As a result, futurestrading was revived, after a lapse of nearlythree and a half decades, towards the close ofthe 20th century.

The year 2003 was a watershed year in thehistory of commodities with the establishment& recognition of three national exchanges withonline trading & professional management. Atpresent, there is a three tier regulatory systemfor commodities futures market viz. theCentral Government, Forward MarketCommission & recognized exchanges. Futurestrading in India are currently permitted in 6national level multi-commodity exchanges and

21 regional level commodity specificexchanges. Futures turnover for the year 2011-12 at commodity bourses in India, the world’sbiggest buyer of bullion and second largestwheat grower, jumped 51.7 percent to 181.26trillion rupees, spurred by gold and agriculturalcommodities. Volumes in agriculturalcommodities jumped 50.79 percent to 21.96trillion rupees in the fiscal year that ended inMarch, 2012 while bullion futures volumesjumped 85.33 percent to 101.82 trillion rupees,as reported by FMC.

Commodity derivatives have witnessedremarkable growth since 2003; neverthelessfingers were still being pointed accusingfutures trading for rising inflation inagricultural commodities. Four essentialcommodities- wheat, urad, tur and rice facedfutures trading ban toward the end of 2006-07. An Expert Committee was set up underthe Chairmanship of Prof. Abhijit Sen toexamine the extent to which futures tradinghad contributed to price rise in agriculturalcommodities. The Committee was unable tofind any causal relationship between price riseand futures trading in view of the short timeperiod during which the futures market havefunctioned & the complexities that arisebecause of a large number of variables thatimpact spot prices.

On one hand are the benefits of commodityfutures trading for price risk management andportfolio diversification and on the other handare the doubts regarding issues of excessivespeculation resulting from derivatives trading.Amidst this background, this paper reviews theempirical studies undertaken in India with theobjective of testing price discovery and impactof futures trading on the spot market volatilityin order to understand how effective themarkets have been in successfully performingthe functions of price discovery and price riskmanagement.

25

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

LITERATURE REVIEW

The performance of commodities futuresmarket can be evaluated using certain broadparameters which include basis risk, pricediscovery, and impact of futures trading onspot price volatility. Review of existingliterature, which has been done with respectto these parameters, is an attempt to identifythe issues that can form the basis of this study.

Basis in context of futures market is thedifference between future and spot price andit assumes importance because it isfundamental to the understanding of the mostimportant functions of futures market viz.hedging. The risk that futures and spot pricesmay not change by the same amount is calledbasis risk and is measured as variance of basis.Therefore, an understanding of basis is veryuseful for the hedging activity to be successful.A few studies have been examined tounderstand the risk arising due to basisvariation.

Theoretical considerations indicate that risk inbasis behavior may vary over the contract lifeas new information becomes available and asit impacts on futures and general level of cashprices. Change in local demand and supplyconditions results in different levels of basisrisk in various markets. On these lines Garcia,Leuthold and Sarhan (1984) have attemptedto measure and analyze within contract basisfor selected livestock commodities (cattle &hogs) and ascertain the variations in basisacross different markets and as contractapproaches maturity. Using Variate Differenceapproach and regression analysis they foundthat not much difference was observed in basisrisk at different market locations. However,as contract approached maturity evidence wasfound of lower levels of risk in basis behaviorindicating increased market information andactivity near maturity influences both futures

& cash position in a similar manner. Therefore,producers & market participants who hedgeare advised to ascertain the level & long termpattern of prices. This will help in identifyingperiod of high basis risk & lead to betterproduction and marketing strategies.Informational content of the basis using barley,oats and canola futures was studied by Khouryand Yourougou (1991) by measuring therelative responsiveness of the basis and of thefutures prices to new information. If the ratioof the variance of the basis to cash pricechanges is much larger than that of futures tocash price changes, one might expect the basisto have a greater forecasting power than thefutures. Results suggest that the futures marketfor the commodities under study is used as theprimary point of price discovery and in thissense they are consistent with theinformational content hypothesis of the basis.They also demonstrate that the basis providesstatistically reliable information about cashprices several weeks before maturity.Therefore prices are discovered in futuresmarkets, and then transmitted to cash markets.Decision to hedge depends on the hedgersforecast of closing basis & whether itrepresents an attractive opportunity ascompared to opening basis.

Castelino (1992) has used Wheat and cornfutures along with financial futures of T-Billand Eurodollar for a period from Jan 1983 toDec 1985 and calculated minimum variancehedge ratios using simple regression analysis.It was observed that a substantial risk reductionis possible through minimum variance hedgingfor T –bills and Eurodollar contracts whereasit is very less in case of commodities.Minimum variance hedge ratios possess a timedimension. They are low for hedges lifted farfrom contract expiration and increase as thehedge lifting date approaches the contractexpiration. Existence of minimum variance

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

26

hedge ratio does not imply that hedge shouldbe used at all times. The major factor inhedging decisions is anticipation of favorablechange in basis.

Netz ( 1996 ) has measured the impact of basisrisk (unexpected changes in basis over time)on cash market position with corn as theunderlying. Basis risk needs importancebecause very few contracts in the futuresmarket are settled through physical delivery.Stockists’ profits are a function of variance ofbasis. Basis risk will negatively impact his cashposition. Results indicated that basis riskreduces the level of storage. Faced with greaterbasis risk the agents reduce their exposure byreducing the level of inventory. Basis riskreduces the effectiveness of futures as a riskmanagement tool or managing price risk. Aone standard deviation increase in basis riskis associated with a decline in storage bybetween 1% and 14% of a standard deviation,depending on the location.

Garcia and Sanders (1996) studied basis riskin live hogs futures market to test whether basisvolatility has increased over the last decade atselected terminal and direct markets. Theyused RMSE( root mean square error) as ameasure of basis risk and tested it by usingprocedures set forth by Ashley, Granger andSchmalensee. Henrikson Merton Timing Testwas used to check whether basis had a positiveor negative sign. Results indicated that in thetwo markets live hog prices behaved similarlyand that there was no meaningful differencein basis. Monthly basis variance was ratherstable in the period 1975-94. Therefore theusefulness of live hog contracts had notdeclined due to unfavorable nature of basisbehavior. The demand for use of futurescontract as hedging instruments may havedecreased due to other factors such as changein structure of hog industry with movements

towards alternative and less costly means ofmanaging price risk.

In the study on castorseed futures market inIndia from 1985 to 1999 Karande (2006) foundthat Basis risk as indicated by RMSE is lowerfor June contract as all information regardingsupply of castorseed is available much beforetrading begins. It is opposite for Decembercontract. Lower RMSE for Ahmedabad marketis due to higher futures trading volume.

Price discovery is another important functionof futures market and it hinges on whether newinformation in the market is reflected first inthe changes in futures prices or changes in spotprices (Hoffman 1932). Through pricediscovery futures market establish acompetitive reference (future) price fromwhich spot price can be derived. Futures pricesserve as the market expectations of subsequentspot prices and can be used by exporters,producers including farmers for optimaldecision making and resource allocation. Pricediscovery function of futures market has beenstudied extensively using various underlyingand at different time periods.

Garbade and Silber (1983) examined thecharacteristics of price movements in spotmarket and futures market for storablecommodities and found that in general futurescontract do not provide a perfect risk transferfacilities in the short time horizon. With respectto price discovery role of futures marketevidence was found of information flow fromfutures to spot market. However, reverseinformation flow from cash market to futuresmarket was also observed. They also foundthat market size and liquidity played a positiverole in the price discovery function.

Oellermann and Farris (1985) investigated leadlag relation between change in futures and spotprice for live beef cattle between 1966 and

27

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

1982. The futures price led spot price duringnearly every sub period analyzed. Based onGranger causality test for various sub samplesof their data, they conclude that change in livecattle futures price led change in live cattlespot price. They also found that the spot marketresponded to change in futures price withinone trading day. The authors conclude thatfutures market was the centre of pricediscovery for live cattle. They suggest that alikely explanation for the results is that thefutures market serves as a focal point forinformation assimilation. They conclude thatthe cattle futures market contributes towardsa more efficient price discovery process in theunderlying spot market for live beef cattle.

Koontz et al. (1990) examined live cattlemarket to study the nature of dominance ofspot or futures market. Their finding was thatspot market was relying less on futures marketfor price discovery.

Study by Quan (1992) on monthly crude oilprices using monthly data also concluded thatspot prices lead futures prices. However,Zapata (2005) examined the relation betweensugar futures prices traded in New York andthe world cash prices for export sugar, findingevidence of futures market leading the spotmarket. Though futures contract are a usefulvehicle for reducing market price risk, the riskreducing performance of such contracts havedeteriorated since 1995 due to increase in basisrisk relative to price risk and also due toincreased market share of speculators.

Figuerola and Gonzalo (2010), chose spot andfutures non-ferrous metals prices (aluminium,copper, lead, nickel and zinc) traded in theLondon Metal Exchange (LME) to test theprice discovery and observed that mostmarkets are in backwardation and futuresprices are “information dominant” in highlyliquid futures markets (Al, Cu, Ni, Zn) while

this was not the same for lead where liquiditywas low.

Empirically testing both the long run and shortrun efficiency of Copper Futures market fromLondon Futures Exchange, Kenourgios andSamitas (2004) found that copper futuresmarket on the London Metal Exchange wasinefficient and the three and fifteen months offutures prices did not provide unbiasedestimates of the future spot prices in both thelong-run and short-run. Markets offeredopportunities for making consistentspeculative profits. However, Leming and Oun(2010) have found evidence of price discoveryin case of steel rebar futures and steel wirerod futures at SHFE (Shanghai FuturesExchange). The Steel Rebar futures play majorrole in price discovery and can be used forhedging risk when the trading volume is high.With a low trading volume, the steel wire rodfutures have less effect than spots in pricediscovery.

Another controversial issue is the impact offuture trading on the prices in underlying spotmarket. Critics of futures market claim that itdestabilizes the spot market by increasing Spotprice volatility as it attracts new speculatorswho do provide liquidity but can also createnoise in the underlying spot market if they areless informed than the traders existing in themarket. The other view is that spot marketvolatility decreases due to the liquidityprovided by speculators. This additionalliquidity allows spot traders to hedge theirpositions and curb volatility. Informationalefficiency of futures market stabilizes the spotmarket. Early research on the effect of futurestrading in commodities has generallyconcluded that the existence of a futuresmarket tends to stabilize price in the spotmarket. Two papers on the onion market byGray (1963) and Working (1960) found that

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

28

futures trading reduced the range between highand low spot price over a crop year.

A study of live cattle futures by Taylor (1974)compared the variance of price between aperiod with and without futures trading andfound that the spot price was more stable whenfutures market was in existence.

Antoniou and Foster (1992) empiricallyinvestigated the effects of the introduction ofa futures contract for Brent Crude Oil in 1988on spot price volatility of Brent Crude in UK.The results of GARCH models indicated thatintroduction of futures market improved thequality of information flowing to the spotmarket & accordingly spot prices reflect morepromptly changes that occur in demand &supply information. Similar results wereindicated by GARCH M model & hence novolatility spillover was found from futures tospot market in case of Brent Crude Oil. Resultsof regression analysis revealed no apparentchange in volatility after introduction of futurescontract

EVIDENCES OF PRICE DISCOVERYAND SPOT PRICE VOLATILITY IN THEINDIAN COMMODITIES MARKET

India has passed through a tumultuous periodand researchers have tried to examine thevarious aspects related to future marketefficiency. The findings of empirical studiesundertaken on different commodities after thecommencement of organized futures tradingare presented in the section below.

Agricultural Commodities

Wheat

Wheat is the second largest cereal grainconsumed on earth and the consumption isexpected to increase from 680 million tons in2009-10 to 775 million tons in 2020. Within

the country, government intervenes in thenormal market functioning to stabilize theprices and supply. Wheat futures were studiedfrom 2004 to 2006 (Raizada & Sahi,2006) forexamining the price discovery and resultsindicated that they are even in weak forminefficient and did not aid in price discovery.Rather, information assimilation was faster inspot market. It was also observed that growthin wheat futures volume had a significantimpact on volatility. Sahi G.S. in another studyagain confirmed the significant impact on spotprice volatility of increase in wheat futurestrading volume & open interest. Ghosh (2010)using the wheat data from 2009-10 also foundthat futures prices did not serve as referenceprice for transacting contracts in physicalmarket. The volume of futures trading was toolow to influence the spot market prices.However, in the period of 2004-07 Mukherjee(2010) used Vector Autoregression techniqueon spot & futures prices and found evidenceof futures market leading spot market. Theresult of GARCH (1,1) showed no volatilityinterdependence in the two wheat markets. Thefindings of the study by Lokare S.M.(2007)for the period 2003-04 gave evidence of highervolatility of wheat futures prices compared tospot prices. Therefore, studies on wheat havegiven mixed results as to the effectiveness offutures trading which may be because wheatbeing an essential food item has been facinggovernment intervention to maintain price andsupply stability.

Pepper

Indian pepper is traded at a premium ininternational markets owing to its superiorquality. In case of pepper, futures market wasfound to be leading the spot market withbidirectional volatility spillover in bothmarkets (Mukherjee, 2010). Even Lokare S.M.(2007) examined that pepper futures market

29

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

was efficient. But in the research byGurbandini, 2010 pepper future contracts werenot fairly priced giving rise to arbitrageopportunities. In a very recent study by DeyK.,2011 on pepper spot & future prices from2006 to 2010, it was observed that there wasunidirectional causality from futures to spotmarket. Also, positive shocks generatedsteeper movement on logarithmic conditionalvariance of spot and future return series ascompared to negative shocks.

Chana

India is the largest producer of chana(chickpea) followed by Pakistan. Chanafutures trading was examined by Abhijit SenCommittee, 2008 to review the spot priceincrease in 2006-07. The committee observedthat no major change in spot price volatilitywas observed after introduction of futurestrading. Low production in 2005-06 couldhave driven up the prices. In a study on pricediscovery, futures prices led spot prices ofchana and there was no evidence of volatilityspillover in the two markets (Mukherjee,2010). Research by Gurbandini, 2010 showedthat closing spot prices of chana for theprevious day had no impact on the openingfuture price of the subsequent day. Also,futures contracts were overpriced on 85% ofthe trading days observed.

Castor Seed

India is the biggest exporter of castor oilholding about 70% share of the internationaltrade. Castor oil is the largest vegetable oilexported out of India. Castorseed market ofMumbai and Ahmedabad from 1986 to 1999was studied by Karande (2007) givingevidence of futures market performing theprice discovery function for all contractsexcept those where the trading volume was tooless. Spot price volatility did increase after the

introduction of futures trading but it stabilizedlater indicating that introduction of futuresaided in information assimilation and had abeneficial impact on spot market volatility.However Mukherjee (2010) found no lead lagrelation and volatility interdependence in spot& future prices.

Soya Oil

Refined soya oil is one of the main consumingedible oil in India and is the leading vegetableoil traded in the international market. Soya Oilfutures led the spot market but there was novolatility spillover from futures to spot market(Mukherjee, 2010). Refined Soya Oil contractswere underpriced for 74% of the observedtrading days ( Gurbandini, 2010)

Chilli

India is the largest producer & exporter of chilliwith domestic demand from the spiceproducing industry increasing at a fast rate.Also, globally Indian chillies are of superiorquality. Though futures market was foundperform the function of price discovery butvolatility spillover was also observed fromfutures to spot market (Mukherjee, 2010)

Jeera

Jeera (Cumin Seed) contract is highly liquidand so is useful for hedgers & speculators aswell. In case of Jeera spot markets wereleading the futures market. Also there wasvolatility spillover from futures to spot market(Mukherjee, 2010)

Mentha Oil

Demand of Mentha Oil comes from the foodand cosmetic industry and India plays asignificant role in the world mentha oil marketbeing the largest producer and exporter of thecommodity. In mentha oil market, futures

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

30

market was leading the spot market with bidirectional volatility spillover in both markets(Mukherjee, 2010)

Mustard Seed

Being an important source of edible oil andfeed meal to the country, mustardseed (RMseed) is the focus of Indian Oilseed Industry.There is considerable price volatility in thephysical and futures RM Seed market.Exchange traded RM seed futures are ideal forthe price risk management needs of producers,traders, processors and end users. Spot pricesof mustarsdeed were leading the future priceswith no volatility interdependence (Mukherjee,2010)

Cotton

India is one of the largest producer &consumers of cotton and in 2010-11 it was theworld’s second largest exporter. Cotton futureswere examined from 2003 to 2004 by Lokare(2007). Futures prices exhibited highervolatility than spot prices with indications ofspeculation in many contracts. However, longrun cointegration was established in bothmarkets.

Rubber

World Natural Rubber (NR) production hasincreased by 43% in the last decade whereasthe consumption has gone up by 47%. Rubberfutures prices variability was higher than thatof spot prices reflecting excessive speculationLokare (2007). Iyer V.,Pillai A (2010)empirically testing the rubber futures contractexamined that rubber futures contract were notuseful for hedging as the informationconvergence was not there in the expirationweek.

PERFORMANCE OF METALS

Gold

Gold futures trading has given India secondranking in the world . Srinivasan K., Deo M.(2009) examined Gold trading for 2005-08 andfound unidirectional causality from spot tofutures market with spot market acting as thecentre for price discovery. However, in anotherstudy, due to sufficient trading volume, futuresmarket was the centre of price discovery andthe information convergence wasinstantaneous in the expiry week. Therefore,it is a useful hedging instrument (Iyer V.,PillaiA 2010). Study by Chaihetphon P., PavabutrP.(2010) on Gold Standard and Mini contractsfrom 2003-07 found futures market to beefficient. Gold Mini contracts (100 grams)contributed to over 30% of price discoverythough they accounted for only 2% of tradingvalue on MCX. Therefore, findings on Goldmarket have been consistent.

Silver

India’s number one metal in terms of futurestrading volume, silver is a much sought aftermetal for being both a precious metal andindustrial commodity. Silver futures contractwas a useful for hedging as price discoverywas taking place in the futures market (IyerV.,Pillai A 2010)

Copper

For copper futures also India enjoys secondrank in the world trading of commodityfutures. After steel and aluminum, copperstands third in terms of world consumption.Copper futures market was found to beefficient and helped in price discovery (IyerV.,Pillai A 2010)

From the research on the commoditiesdiscussed above, it appears that though futures

31

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

market is playing its role for somecommodities, yet anomalies are also seenwhich make it essential to expand the researchefforts put so far. Also, there are a host ofcommodities being traded on Indiancommodity exchanges which are still notinvestigated as to their futures marketperformance. Organized commodity futurestrading in India are relatively new comparedto developed markets of U.S., U.K., China,Japan etc, but the volume is picking up at avery fast rate. Many times the functioning ofthe markets has been disrupted by uninformedspeculation. As a result, government hasimposed strict regulations to the extent ofsuspending the futures trading in certaincommodities. This hampers the real purposeof derivative instruments, that is, price riskmanagement and price discovery and theirutility gets fraught with doubts & suspicionby the end users. To understand the realproblems faced and to come out with workablesolutions there is a need to carry extensiveresearch on various issues of commoditymarkets. Much of the research done so far hasbeen confined to framework of financialeconomics which involve modeling therelation between spot and futures prices in afew regression equations. This according tosome experts gives a reductionist perspectiveto the nuances of commodity markets. It is alsoimportant to examine issues like problems inthe actual transaction process, study of marketmicrostructure, role of market participants,regulators etc.

CONCLUSION

Commodity prices are very critical for theexistence & growth of any industry and forthe economy as a whole. Our government hasbrought about sweeping reforms in thecommodities markets so that industry can

efficiently manage the price risk they are facedwith. This was the rationale behind promotingand encouraging futures markets forcommodities. However, Indian markets arestill nascent compared to their counterparts inUS and China. Many apprehensions preventaverage traders from using them for mitigatingthe uncertainties under which they do business.With increasing demand the strain oncommodities is going to increase in the timesto come. Commodity prices will continue tobehave unpredictably. Risk managementthrough commodity derivatives will givestability to the economic activities of thecountry. Therefore, extensive research isrequired in this area to continuously bring outissues that need to be attended for the growthand development of commodities market.

REFERENCES[1] Aggarwal R. and Sundararaghavan P.S.

(1987), “Efficiency of Silver FuturesMarket-An empirical study using dailydata”, Journal of Banking & Finance, Vol.11 No. 1.

[2] Ahuja, N. L. (2006), “CommodityDerivatives Market in India: Development,Regulation and Future Prospects”,International Research Journal of Financeand Economics; Issue 2

[3] Antoniou A, Andrew, J. F. (1992), “TheEffect Of Futures Trading On Spot PriceVolatility: Evidence For Brent Crude OilUsing Garch”, Journal of Bunness Finance& Accounting, Vol. 19 No (4).

[4] Bose S (2008), “Commodity Futures Marketin India - A Study of Trends in the NotionalMulti-Commodity Indices”, ICRA Bulletinof Money and Finance.

[5] Bose S. (2009), “The Role of FuturesMarket in Aggravating Commodity PriceInflation and the Future of CommodityFutures in India”, ICRA Bulletin of Moneyand Finance

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

32

[6] Calvo, G. (2008), “Exploding CommodityPrices, Lax Monetary Policy, and SovereignWealth Funds”, VoxEU, 20 June, availableat http://www. voxeu.org/index.php?q=node/1244.

[7] Chaihetphon P. and Pavabutr, P.(2010),“Price Discovery in Indian Gold FuturesMarket”, Journal of Economics &Finance,Vol.34 No. 4.

[8] Dhuyvetter K.C., Swanser K., Kastens T.,Mintert J. and Crosby B.(2008), “ImprovingFeeder Cattle Basis Forecasts”, Selectedpaper for 2008 Western AgriculturalEconomics Association Meeting, Big Sky,MT.

[9] Dimitris,K. F. and Aristeidis, S. G. (2004),“Testing Efficiency of the Copper FuturesMarket: New Evidence from London MetalExchange”, Global Business andEconomics Review, Anthology.

[10] Figuerola I.F. and Gonzalo J., (2010),“Modelling and measuring price discoveryin commodity markets”, Journal ofEconometrics, Vol.158, pp. 95-107.

[11] Garbade, K. D. and Silber, W. L. (1983),“Price movements and price discovery infutures and cash markets”, The Review ofEconomics and Statistics, Vol. 65 No. 2.

[12] Garcia, P., Leuthold, R. M. and Sarhan, M.E. (1984), “Basis risk: measurement andanalysis of basis fluctuations for selectedlivestock markets”, American Journal ofAgricultural Economics, Vol. 66 No. 4, pp499–504.

[13] Garcia, P. and Sanders, D. R. (1996), “Exante basis risk in the live hog futurescontract: has hedgers’ risk increased?”, TheJournal of Futures Markets, Vol. 16 No. 4,pp 421–430.

[14] Ghosh, N. (2008), “Price Discovery inCommodity Markets: Floated Myths”,Flouted Realities Commodity Vision, Vol.1, No 3.

[15] Ghosh, N. (2009), “Issues and Concerns ofCommodities Derivatives Markets in India:An agenda for further research”, Workingpaper No.5.

[16] Ghosh, N. (2010); “Role of thin commodityfutures market in physical markets pricemaking: An analysis of wheat futures inIndia in post ban era”, Working Paper No.6.

[17] Gray, R. (1963), “Onions revisited”, Journalof Farm Economics, Vol. 45, pp 273–76.

[18] Gupta.K. and Singh, B. (2009), “PriceDiscovery and Arbitrage Efficiency ofIndian Equity Futures and Cash Markets”;Working Paper.

[19] Holbrook Working (1960), “Price effects offutures trading”, Food Research InstituteStudies, pp 13–31.

[20] Iyer V., Pillai.A. (2010), “Price Discoveryand Convergence in Indian CommoditiesMarket”, Indian Growth and DevelopmentReview, Vol.3 No.1, 53-61.

[21] Jackline, S. and Deo, M. (2011), “Lead LagRelationship between Futures and SpotPrices”, Journal of Economics andInternational Finance, Vol. 3 No 7, pp 424-427.

[22] Kaur, G. and, Rao D. N. (2010), “Do thespot prices influence the pricing of futurecontracts? An empirical study of pricevolatility of future contracts of selectagricultural commodities traded onNCDEX”, Journal of ManagementResearch, Vol. 10 No. 2, pp. 116-132.

[23] Karande, K. (2006), “A Study of CastorseedFutures Market in India”, Doctoral, IndiraGandhi Institute of Development ResearchMumbai, India

[24] Khalifa, A. A., Hong, M., and Ramchander,S. (2011), “Return Distribution andVolatility Forecasting in Metal FuturesMarket: Evidence from Gold, Silver andCopper”, Journal of Futures Market, Vol.31 No. 1, pp 55–80.

[25] Khoury N.T., and Yourougou P. (1991),“The Informational Content of the Basis:Evidence from Canadian Barley, Oats, andCanola Futures Markets”, The Journal ofFutures Markets, Vol. 11 No. 1, pp 69-80.

[26] Lemin, T. and Oun, Z. (2010), “Study onthe Price Discovery Function of China Steel

33

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

Futures, Management and Service Science(MASS)”, 2010 International Conference,Wuhan

[27] Lokare, S. M. (2007), “CommodityDerivatives and Price Risk Management:An Empirical Anecdote”, Reserve Bank ofIndia Occasional Papers, Vol. 28 No. 2.

[28] Maniar.H.M., Maniyar D.M., and Bhatt, R.(2007 ), “Arbitrage Opportunities inIntraday Trading between Futures, Optionsand Cash Markets-A case study on NSEIndia”, 10th Indian Institute of CapitalMarkets Conference Paper.

[29] Mark G. C. (1992), “Hedge effectiveness:basis risk and minimum variance hedging”,The Journal of Futures Markets, Vol. 12 No.2, pp 187–201.

[30] Mukherjee, K. N. (2010), “Impact ofTrading on Indian Agricultural CommodityMarket”, Research Project at NationalInstitute of Bank Management, http://ssrn.com/abstract=1763910.

[31] Nath, G. C. and Lingareddy, T. (2008),“Commodity derivative market and itsImpact on Spot Market”, Working PaperSeries.

[32] Netz, J. S. (1996), “An empirical test of theeffect of basis risk on cash marketpositions”, The Journal of Futures Markets,Vol. 16 No. 3, pp 289–311.

[33] Oellermann, C. M. and Farris, P. L. (1985),“Futures or cash: which market leads livebeef cattle, prices?”, The Journal of FuturesMarkets, Vol. 5 No. 4.

[34] Paschke. R and Marcel. P (2009), “Investingin Commodity Futures Markets: Can PriceModels Help?” Conference of the SwissSociety for Financial Market Research2009 , Geneva, http://ssrn.com/abstract=1348470

[34] Quan, J. (1992), “Two step testingprocedure for price discovery role of futuresprices”, The Journal of Futures Markets,Vol. 12 No. 2, pp 139–49.

[35] Raizada, G. and Sahi, G.S. (2006),“Commodity Futures Market Efficiency in

India and Effect on Inflation”, WorkingPaper, Indian Institute of Management(Lucknow), India.

[36] Sahi, G S, “Influence of CommodityDerivatives on Volatility of Underlying”,Working Paper, Indian Institute ofManagement (Lucknow), India.

[37] Sen, A. (2008), ‘Report of the ExpertCommittee to Study the Impact of FuturesTrading on Agriculture Commodity Prices’submitted to Ministry of Consumer Affairs,Food & Public Distribution Government ofIndia.

[38] Srinivasan K. and Deo M. (2009), “TheTemporal Lead Lag and Causality betweenSpot and Futures Markets: Evidence fromMulti Commodity Exchange of India”,International Review of Applied FinancialIssues and Economics, Vol. 1 No. 1.

[39] Stephen R,. Koontz, P. G. and Hudson, M.A. (1990), “Dominant–satellite relationshipbetween live cattle cash and futuresmarkets”, The Journal of Futures Markets,Vol. 10 No. 2, pp 123–36

[40] Taylor, G. S. and Raymond M. L.(1974),“The influence of futures trading on cashcattle price variations”, Food ResearchInstitute Studies, Vol. 13, pp. 29–35.

[41] UNCTAD Trade & Development Report(2011), By the secretariat of the UnitedNations Conference on Trade andDevelopment, New York and Geneva.

[42] Vipul (2005), “Temporal variations infutures mispricing”, Vikalpa, Vol. 30 No. 4.

[43] Vipul (2008), “Mispricing, Volume,Volatility and Open Interest: Evidence fromIndian Futures Market”, Journal ofEmerging Market Finance, Vol. 7 No. 3, pp263–292.

[44] Zapata H., Fortenbury T.R., and ArmstrongD., (2005), “Price Discovery in the WorldSugar Futures and Cash Markets:Implications for the Dominican Republic”,Staff Paper No.469, University ofWisconsin-Madison

ANVESHANAM- A NATIONAL JOURNAL OF MANAGEMENT [VOL.1, NO.1, AUGUST 2012-JULY 2013]

34

NOTES:[1] [Online] Available: http://

www.oxfordfutures.com/history.htmassessed on 2.05.11

[2] [Online] Available: http://www.thecityuk.com/media/216938/commodities%20trading%202011.pdfassessed on 2.05.11

[3] Task Force on Commodity Futures Markets,Report to the Financial Stability Board,Technical committee of the InternationalOrganization of Securities Commissions,OR01/11, April 2011.

[4] [Online] Available: http://in.reuters.com/article/2012/04/11/india-commodity-

exchanges-idINDEE83A0BL20120411dated: 11 april 2012

[5] The report of “The Expert Committee tostudy the Impact of Futures Trading onAgricultural Prices” 2008.

[6] [Online] Available: http://www.ibef.org/economy/agriculture.aspx assessed on2.05.11

[7] Government of India (September 2003)Draft report of the inter-ministerial taskforce on convergence of securities andcommodity derivative markets, Ministry ofConsumer Affairs, Food and PublicDistribution, New Delhi.