Futures Market Failure?

40 Pages Posted: 28 Oct 2011  

Philip Garcia

University of Illinois at Urbana-Champaign - Department of Agricultural and Consumer Economics

Scott H. Irwin

University of Illinois at Urbana-Champaign - Department of Agricultural and Consumer Economics

Aaron Smith

University of California, Davis - Department of Agricultural and Resource Economics

Date Written: October 25, 2011

Abstract

In a well-functioning futures market, the futures price at expiration equals the price of the underlying asset. This condition failed to hold in grain markets for most of 2005-10. During this period, futures contracts expired up to 35% above the cash grain price. We develop a rational expectations model to show how non-convergence arises from a wedge between the price of storing the physical commodity and the cost of carrying the delivery instrument. This wedge is the coupon in a present value equation, so our results exemplify a significant financial market in which a present value model explains prices.

Keywords: finance, agriculture, commodity futures, delivery, grain, storage, present value, asset pricing

JEL Classification: G13, G14, Q11, Q13

Suggested Citation

Garcia, Philip and Irwin, Scott H. and Smith, Aaron, Futures Market Failure? (October 25, 2011). Available at SSRN: https://ssrn.com/abstract=1950262 or http://dx.doi.org/10.2139/ssrn.1950262

Philip Garcia

University of Illinois at Urbana-Champaign - Department of Agricultural and Consumer Economics ( email )

1301 W. Gregory Drive
427 Mumford Hall
Urbana, IL 61801
United States
217-333-0644 (Phone)
217-333-5538 (Fax)

Scott H. Irwin

University of Illinois at Urbana-Champaign - Department of Agricultural and Consumer Economics ( email )

1301 W. Gregory Drive
326 Mumford Hall, MC-710
Urbana, IL 61801
United States

Aaron D. Smith (Contact Author)

University of California, Davis - Department of Agricultural and Resource Economics ( email )

One Shields Avenue
Davis, CA 95616
United States
530-752-2138 (Phone)
530-752-5614 (Fax)

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