Price Discovery in India’s Agricultural Commodity Futures Markets

Abstract

Commodity futures market plays an important role in price discovery, the information on which helps the producers to plan their activities on production, processing, storage, and marketing of commodities. It is generally argued that price discovery is more efficient in futures market than spot market (Brockman and Tse, 1995; Yang and Leatham, 1999). The availability and effective dissemination of information helps to stabilise and decreases spot price volatility. Thus, futures trading infuse efficiency in the functioning of a commodity market (Tomek, 1980; Karnade, 2006). In general, futures prices reflect the collective expectations of market agents about prospective demand and supply of commodities at maturity of futures contract. Since the futures prices are a reflection of futures demand and supply conditions of markets, they provide market signals to the farmers for deciding the appropriate cropping pattern. If future prices are falling, then it implies either future demand would fall or the supplies would ease out and vice versa. Through hedging, farmers can mitigate the price risk that they may face in the spot market with volatile prices. It enables traders to buy the crop during harvest season, paying the farmers with fair prices, which are reflective of its “scarcity value”. Storing them until the new harvest and releasing it in small quantities will maintain price stability between crop seasons as being done mostly by the intermediaries. However, even in the well functioning markets, the movement of spot and futures prices would not be perfectly parallel, so it can only reduce risks through executing opposite selling and buying in two markets rather than altogether removing them. On the contrary, it is argued that futures trading affect the spot markets by increasing price volatility in the spot markets. This is based on the assumption that future markets are thin and thus inefficient and the spot traders tend to follow the