A note: Do futures prices always reflect the cheapest deliverable grade of the commodity?
✍ Scribed by Betsey A. Kuhn
- Publisher
- John Wiley and Sons
- Year
- 1988
- Tongue
- English
- Weight
- 292 KB
- Volume
- 8
- Category
- Article
- ISSN
- 0270-7314
No coin nor oath required. For personal study only.
✦ Synopsis
DO FUTURES PRICES ALWAYS REFLECT THE CHEAPEST DELIVERABLE GRADE OF THE COMMODITY?
his note concerns the price behavior of multi-grade futures contracts.
the cash price of the least expensive quality of the commodity deliverable on the futures contract, allowing for any quality differentials specified in the futures contract. Yet casual observation of the Coffee, Sugar & Cocoa Exchange, Inc. (CSCE) coffee C futures market suggests that instead, futures prices tend to reflect cash prices for the most widely traded growths of coffee deliverable on the contract. This note suggests three possible accounts of what information the futures price might reflect. Each account is tested against data from the coffee market.
T According to the most widely accepted theory, futures prices should reflect
PRICE BEHAVIOR OF MULTIGRADE FUTURES CONTRACTS
Many futures contracts permit more than one grade of a commodity to be delivered to satisfy the contract. One or more grade(s) are designated as the par grade and the remainder as the nonpar grades. Fixed or variable premiums and discounts, called quality differentials, are then specified for the nonpar grades. These differentials are supposed to compensate both the long and the short for not receiving or delivering the par grade of the commodity. Ideally, the long is indifferent as to whether or not he or she receives the par grade of the commodity and the short is indifferent as to which grade he or she delivers. However, when differentials are fixed, as they are on the coffee C futures contract, and the differences among cash prices for different grades change, one grade of the commodity may be cheaper to deliver than another, 'The author gratefully acknowledges Paula Tosini, Eugene Moriarty, and John Bird for helpful comments, David Borowski, Margaret Burke, and Jeffrey Muti for their assistance with the empirical work, and Joanne Simmons for her help in preparing the paper for publication. The views expressed are those of the author and should not be attributed to the CFTC or its staff.