An empirical examination of the efficiency of commodity markets in India

Abstract

India’s growing economic clout within the emerging market club has resulted in a steady proliferation of innovative financial products entering the capital markets. With an expansive economy presenting enormous opportunities for businesses to earn superior rates of return on capital outlays, the inherent risks arising out of a volatile global economic climate driven by a slew of geo-political factors exert enormous pressure on the management of corporations to devise strategies that are effective in mitigating some of these risks. In recent years, India has been a witness to heightened interest being evinced by financial managers towards skilfully deploying financial instruments like Futures and Options in order to overcome the uncertainty arising out of fluctuations occurring in the prices of underlying assets 1 . In this context, the role of commodity markets assumes considerable significance. Emergence of organized and sophisticated commodity markets like NCDEX (National Commodities and Derivatives Exchange) and MCX (Multi-commodity Exchange) has enabled the participants of this specialized market to strategically hedge their positions in the backdrop of volatilities witnessed in prices of underlying commodities. An implied postulate necessary for the successful performance of the hedging function is the operation of market efficiency that serves as a necessary condition for organized functioning of the market, which becomes the basis for an efficient price-discovery mechanism. In this paper, we endeavour to examine the efficiency of commodity markets in India by resorting to a rigorous econometric model. By underscoring the need to establish a relationship between the Futures and Spot markets (given that they depict a time-series behaviour), the model is better poised to examine the empirical validation of market efficiency in comparison to alternative models (variance-ratio test, jarque-bera test, and runs test etc.) that have traditionally relied upon the observed behaviour of Spot prices alone to validate the enshrined objectives. A conspicuous absence of studies involving employment of statistically robust models like cointegration regression in respect of examination of efficiency of commodity markets in emerging economies like India presents a compelling reason to undertake the present study. We employ the popular cost-ofcarry model to empirically examine the hypothesis involving efficiency of commodities market in India 2 . We reject the cost-of-carry model using both single-hypothesis and joint-hypothesis tests depicting a weak evidence of market efficiency.