Market efficiency of commodity futures in India

Abstract

This article aims to examine the market efficiency of the commodity futures market in India, which has been growing phenomenally over the last few years. We estimate the long-run equilibrium relationship between multi-commodity futures and spot prices and then test for weak-form market efficiency by applying both the dynamic ordinary least squares and fully modified ordinary least squares methods. The entire sample period is from 2 January 2006 to 31 March 2011. The results indicate that a cointegrating relationship exists between these indices and that the commodity futures market appears efficient during the more recent sub-sample period since July 2009 onwards.

Keywords:

• commodity
• futures market
• India
• market efficiency

JEL Classification:

• G13
• G14

Acknowledgement

We are grateful to an anonymous referee for helpful comments and suggestions.

Notes

¹ The Indian Commodity Exchange and Ace Derivatives and Commodity Exchange were later recognized as the fourth and fifth national multi-commodity exchanges in India in 2009 and 2010, respectively.

² Fama (1970) classified market efficiency into three categories: weak-form efficiency, semi-strong-form efficiency and strong-form efficiency. As proposed by Fama (1970), we consider a market weak-form efficient if its futures prices reflect all the available information for predicting the futures spot prices but the participants are unable to consistently make profits. Unlike weak-form efficiency, semi-strong efficiency indicates that all public information is calculated into the current prices, while strong-form efficiency indicates that all information in a market, whether public or private, is accounted for in prices.

³ The formal futures market was originated in the Osaka rice market during Japan’s Tokugawa Era (see Schaede (1989) and Hamori et al. (2001)).

⁴ Easwaran and Ramasundaram (2008) and Vishwanathan and Pillai (2010) examined the Indian commodity futures market by using techniques other than cointegration.

⁵ We also divide sub-sample A into two sample periods: from the period 2 January 2006 to 30 June 2008 and from the period 1 July 2008 to 30 June 2009. However, we obtained similar results.