Price Non-Convergence in Commodities: A Case Study of the Wheat Conundrum
SOAS Department of Economics Working Paper Series, No.185
33 Pages Posted: 21 Apr 2019
Date Written: October 01, 2013
The close relationship between commodity future and cash prices is critical for the effectiveness of risk management and the functioning of price discovery. However, in recent years, commodity futures prices, across the board, have appeared increasingly detached from prices on physical markets. This paper argues that while various factors, identified in previous literature, which introduced limits to arbitrage have facilitated non-convergence, the actual extent of non-convergence in these markets is caused by essential differences in the mechanisms of price formation on physical and derivative markets. With reference to the particular case of the CBOT wheat market, the paper shows that the size of the spread between futures and cash prices can be theoretically and empirically linked to the increasing inflow of financial investment into commodity futures markets.
Keywords: commodity futures, commodity price formation, financialisation, nonconvergence
JEL Classification: D82, D84, G13, G14, Q11, Q14
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