A New Look at the Efficiency & Volatility of Indian Agricultural Commodity Futures Markets

Abstract

Indian agricultural commodity futures market is in the nascent stage. Since lifting of ban on futures trading in the beginning of this millennium, it is still facing serious threat from learned and the lay. Like any other futures market, Indian agricultural commodity futures markets are also expected to perform the role of price discovery and risk management. After having outlined the present status of Indian agricultural commodities market, a comprehensive study on the interrelationship between the spot and futures prices of 15 agricultural commodities is carried out to understand the dynamics of the co-integration, price causality and volatility factors which determine the efficiency of those markets for the period which stand different by various economical and market conditions, for arriving at relative conclusions. The Johansen’s co-integration test on the spot and futures data of the 15 agricultural commodities has shown that the spot and futures market were co-integrated). This proved that the market was efficient and the agriculture commodity futures exchanges provided efficient hedge against price risk emerging in respective commodities. The co-integration between spot price and future spot prices is the indication of efficiency and developed nature of the market. The Granger Causality Test results on the direction of flow of information between the spot and futures market shows that in majority (9 out of 15) of the commodities there were bi-directional flow of information. This shows that due to information flow from both sides, spot to future markets and future market to spot market, both were equally responsible for the price discovery process. The unidirectional causal relationship exhibited in six (6) commodities showed that futures market is leading the spot market. Whereas in terms of volatility, the GARCH test results show that there is volatility clustering and persistence throughout the study period. Even the Granger causality test on volatility revealed that the causation of volatility was bi-directional in 10 commodities. To be specific, we show that Indian agricultural commodities markets are highly efficient during the study period, including the period of price spikes and price distortions. The results of this study, stated above, shows that Indian agricultural commodity futures trading is highly efficient and playing the role it is supposed to play pretty good. The conclusions would certainly serve the concerned policy makers in decision making. Let us expect that the scenario of suspension and ban on futures trading in agricultural commodities is not repeated again, in the interest of Indian farmers. In-spite-of the above positive indications of the efficiency of Indian agriculture commodity market, it has witnessed massive and prolonged price escalations since 2007. The price spikes may be attributed to other fundamental factors not related to the scope of a futures exchange and call for further research.