Do Asset Prices Reflect Fundamentals? Freshly Squeezed Evidence from the Oj Market

NYU-Stern, Finance Working Paper No. FIN-03-011

54 Pages Posted: 10 Jun 2003

See all articles by Jacob Boudoukh

Jacob Boudoukh

Interdisciplinary Center (IDC) Herzliyah; AQR Capital Management, LLC

Matthew P. Richardson

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); AQR Capital Management, LLC

Jeffrey YuQing Shen

JP Morgan Fleming Asset Management

Robert Whitelaw

New York University; National Bureau of Economic Research (NBER)

Multiple version iconThere are 5 versions of this paper

Date Written: February 2003

Abstract

The behavioral finance literature cites the frozen concentrated orange juice (FCOJ) futures market as a prominent example of the failure of prices to reflect fundamentals. This paper reexamines the relation between FCOJ futures returns and fundamentals, focusing primarily on temperature. We show that when theory clearly identifies the fundamental, i.e., at temperatures close to or below freezing, there is a close link between FCOJ prices and that fundamental. Using a simple, theoretically-motivated, nonlinear, state dependent model of the relation between FCOJ returns and temperature, we can explain approximately 50% of the return variation. This is important because while only 4.5% of the days in winter coincide with freezing temperatures, two-thirds of the entire winter return variability occurs on these days. Moreover, when theory suggests no such relation, i.e., at most temperature levels, we show empirically that none exists. The fact that there is no relation the majority of the time is good news for the theory and for market efficiency, not bad news. In terms of residual FCOJ return volatility, we also show that other fundamental information about supply, such as USDA production forecasts and news about Brazil production, generate significant return variation that is consistent with theoretical predictions. The fact that, even in the comparatively simple setting of the FCOJ market, it is easy to erroneously conclude that fundamentals have little explanatory power for returns serves as an important warning to researchers who attempt to interpret the evidence in markets where both fundamentals and their relation to prices are more complex.

Keywords: excess volatility, nonlinear, state dependence

JEL Classification: G1

Suggested Citation

Boudoukh, Jacob and Richardson, Matthew P. and Shen, Jeffrey YuQing and Whitelaw, Robert F., Do Asset Prices Reflect Fundamentals? Freshly Squeezed Evidence from the Oj Market (February 2003). NYU-Stern, Finance Working Paper No. FIN-03-011. Available at SSRN: https://ssrn.com/abstract=396645 or http://dx.doi.org/10.2139/ssrn.396645

Jacob Boudoukh (Contact Author)

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Matthew P. Richardson

New York University (NYU) - Department of Finance ( email )

44 West 4th Street
Suite 9-190
New York, NY 10012-1126
United States
212-998-0349 (Phone)
212-995-4233 (Fax)

National Bureau of Economic Research (NBER)

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United States

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Jeffrey YuQing Shen

JP Morgan Fleming Asset Management ( email )

522 Fifth Ave.
New York, NY 10036
United States

Robert F. Whitelaw

New York University ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0338 (Phone)
212-995-4233 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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