Agricultural Price Transmission Elasticity: Importance of Controlling for Unobservable Common Factors

Abstract

A voluminous literature estimates price transmission from world markets to domestic markets ignoring unobserved common factors that affect all the domestic markets. This paper reconsiders the long-run and short-run transmission elasticity of world commodity price shocks to domestic markets using a ‘common factor framework’ that takes common factors that are correlated with regressors into consideration. In the estimation, we use annual price data for rice, wheat and maize for a panel of developed and developing countries observed over the period of 1960-2007. We compare results from a common factor framework to those that do not account for common factors. Our findings suggest ignorance of common factors is likely to result in upwardly biased elasticity estimates.