Price Discovery and Market Efficiency: Evidence from Agricultural Commodities Futures Markets

This study is an investigation into the futures markets in agricultural commodities in India. The results obtained from regressions for a sample of five commodities traded in six exchanges reveal that these futures exchanges fail to discover prices and provide efficient hedge against the risk emerging from price volatility. The futures markets in these commodities are not efficient and futures prices are not unbiased predictors of the future ready rates. The analysis also reveals that futures markets are unable to effectively incorporate information. The time series data in respect of spot prices and futures prices exhibit presence of unit roots implying weak-form of market efficiency. The cointegration tests reveal that the futures and ready markets do not have long-term equilibrium relationship. INTRODUCTION The Indian futures markets for agricultural commodities have not yet matured as efficient mechanisms of risk management and price discovery. In spite of the high volume in domestic as well as international trade in the physical markets and high price variability of many commodities traded in futures, the use of futures is quite limited as is evidenced by low volume of transactions in the commodity exchanges in India (Sahadevan, 2002). Derivatives like forwards, futures, options and swaps, which are extensively used in many developed as well as developing countries in the world have not yet become very popular in India. A number of restrictions placed by the government on production, supply and distribution of many agricultural commodities are responsible for inhibiting the development of futures markets and limiting their role in the process of price discovery of agricultural commodities. The objective of this paper is to examine the efficiency of agricultural commodity futures markets in India and to identify some of the major impediments obstructing its orderly development. The paper also attempts to empirically investigate, how efficient is the price discovery function of futures for ensuring better hedge against price uncertainty in some selected commodities. Part I of the paper brings out salient features of agricultural commodities futures markets in India while part II contains an econometric analysis of functioning of these markets. SALIENT FEATURES OF AGRICULTURAL COMMODITIES FUTURES MARKETS IN INDIA EVOLUTION OF FUTURES MARKETS Although, India has a long history of trade in commodity derivatives, this sector remained underdeveloped due to government intervention in many commodity markets to control prices. The production, supply and distribution of many agricultural commodities are still governed by the state and forwards and futures trading are selectively introduced with stringent controls. Free trade in many commodity items is restricted under the Essential Commodities Act (ECA), 1955 and Agriculture Produce Marketing Committees (APMC) Acts of various state governments. The forward and futures contracts were, till very recently, limited to only a few commodity items under the Forward Contracts Regulation Act (FCRA), 1952. The Bombay Cotton Trade Association set up the first commodity exchange in India and formal organized futures trading started in cotton in 1875. Subsequently, many exchanges came up in different parts of the country for futures trade in various commodities. The Gujrati Vyapari Mandali came into existence in 1900, which undertook futures trade in oilseeds for the first time in the country. The Calcutta Hessian Exchange Ltd and East India Jute Association Ltd were set up in 1919 and 1927 respectively for futures trade in raw jute. In 1921, futures in cotton were organized in Mumbai under the auspices of East India Cotton Association (EICA). Many exchanges were set up in major agricultural centres in north India before the World War broke out and they were mostly engaged in wheat futures until it was prohibited. The existing exchanges in Hapur, Muzaffarnagar, Meerut, Bhatinda, etc. …