Market Efficiency and Price Discovery in Cocoa Markets

ABSTRACT

This paper tests the efficiency and price discovery mechanism in the cocoa cash and futures markets over the period March 1981–August 2009. The results indicate that the price discovery is done in the cash market and spreads to the futures markets and that the futures price can be seen as an unbiased predictor of future cash prices. There is no sign of a risk premium in the futures price. Since the cash behaves like a random walk we cannot reject market efficiency.

KEYWORDS:

• Efficient markets
• price discovery
• commodities

JEL CLASSIFICATION:

• C12
• C22
• G13
• G14

Notes

1. The volume of cocoa traded in futures contracts is ten times higher than actual world production.

2. Cocoa future is traded only in two exchanges, thus, London International Financial Futures and Options Exchange (LIFFE) and New York Board of Trade (NYBOT).

3. The data series were obtained from Norma’s Historical Data: www.normashistoricaldata.com.

4. The US is the leading importer of cocoa products such as cocoa butter, liquor, and powder – accounting for 15% of world imports in recent years. Ghana, Cote d’Ivoire, Nigeria and Cameroon together account for 70% of world cocoa beans exports (Gibson, 2007).

5. Since the parameters of the VAR uninteresting they are not shown here. It is the fit of the model and the residual process that matters for the test. Seasonal dummies were found to be non-significant for all tested models, and where therefore left out in the final model. The two dummies where selected on the basis that they were clearly visible in graphs and bigger than +/- 3.5 the standardized residual process.

6. This cointegration test is based on a restricted constant term in each difference equation in the VECM (often referred to as Model 2 in Johansen’s approach), and one constant term in the cointegrating vector.

7. In addition to the models in Table 6, we also run autoregressive model with longer lag structures, without finding any significant parameters in the lag structure. These additional results are available from the authors on request.

8. We have performed additional tests that shows the same results, which are available from the authors on request.