Do the Spot Prices Influence the Pricing of Future Contracts? An Empirical Study of Price Volatility of Future Contracts of Select Agricultural Commodities Traded on NCDEX (India)

Abstract

The paper focuses on empirically researching the correlation between spot and future prices to ascertain the extent to which spot prices impact the prices of future contracts for select four agricultural commodities, namely, Chana, Pepper Malabar, Refined Soya Oil and Guar seed. These four commodities contribute approximately 62% of the total volume of agricultural commodities traded on NCDEX. The total turnover of the above commodities by end of August 2009 was Rs 30.68 billion and the total turnover at Exchange level was Rs 49.15 billion.

Further, an attempt has been made to investigate whether future contracts are fairly priced for these products to ascertain the existence of arbitrage opportunities. The paper considered all the contracts of the above commodities over a period of 13 months, i.e., July 2008 to July 2009 (both the months inclusive).

In all 27 future contracts were analyzed over a period of 13 months (July 2008 to July 2009) and eight hypotheses were formulated and tested concerning the volatility of spot and future contract prices, effect of Spot closing prices on opening prices of future contracts and pricing of future contracts. Further, the study also explored the extent of bandwidth in which overpricing and underpricing of future contracts took place.

The study concluded that (i)no significant volatility has been observed in the prices of spot and future contracts of the chosen agricultural commodities. The spot and future prices have closely tracked each other in most of the cases (21 out of 27 contracts); (ii) Future contracts of Pepper and Guar seeds were not fairly priced (supported by statistical evidence) while not much can be inferred about the Future contracts of Refined Soya oil and Chana due to lack of sufficient statistical evidence; (iii) Underpricing of Future contracts lent scope for arbitrage opportunity but however it depended on the type of commodity, timing and the magnitude of underpricing. Scope for further research was suggested.

Keywords: Volatility, Spot price, future contracts, agricultural commodities, underpricing, overpricing, trading days,Chana, Pepper, Guar seed, Soya