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Why do expiring futures and cash prices diverge for grain markets?
Author(s) -
Aulerich Nicole M.,
Fishe Raymond P. H.,
Harris Jeffrey H.
Publication year - 2011
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.20483
Subject(s) - futures contract , cash , economics , financial economics , spread trade , forward market , deliverable , finance , management , corporate governance , open end fund , institutional investor
In recent years, cash and futures prices have failed to converge at expiration for selected corn, soybean, and wheat commodity contracts. This lack of convergence raises questions about the effectiveness of arbitrage activities, and increases concerns about the usefulness of these contracts for hedging. We describe the delivery process for these contracts, and show that it embeds a valuable real option on the long side—the option to exchange the deliverable for another futures contract. As the relative volatility of cash and futures prices increases, this option increases in value, which disconnects the cash market from the deliverable instrument in a futures contract. Our estimates of this option's value show that it may create significant price divergence. We parameterize an option pricing model using data on these three commodities from 2000 to 2008 and show that the option model fits closely to recent episodes of non‐convergence, which lends support to the importance of real option effects. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark Hedging works primarily because changes in futures prices generally track with changes in cash prices. The delivery process forges the cash‐futures link. So strong is that link that the futures price equals the cash price at expiration at the futures delivery location. —Chicago Board of Trade Handbook of Futures and Options (2006)