Testing Efficiency in Agricultural Commodity Futures Market in India Using Cointegration and Causality Tests

Abstract

Purpose: As far as the utility of market based instruments is concerned, there is always a dilemma regarding the stability and role of futures contracts in the development of underlying agricultural commodity markets. The objective of the current study was to test whether the agricultural commodity market in India was efficient or not. This objective was achieved by measuring the relationship between futures and spot market prices of seven major agricultural commodities traded at the National Commodity&Derivative Exchange in India.

Research Design: In the current study, the efficiency of the futures market for seven agricultural commodities was explored by using Johansen's cointegration analysis and Granger causality test. Unit root test such as Augmented Dickey-Fuller and non-parametric Phillips-Perron test were initially applied to test stationarity of spot and futures prices.

Findings: The results showed that their existed cointegration in futures and spot prices for all the selected agricultural commodities. This confirms a long-term relationship between futures and spot prices for all the agricultural commodities like wheat, castor seed, chilly, jeera, pepper, mustard, and soybean. The causality test further distinguished and categorized the commodities based on direction of relationship between futures and spot prices. Granger causality results showed unidirectional causality, where futures market prices lead to spot prices for wheat, castor seed, and jeera as compared to chilly, pepper, mustard, and soybean, where bi-directional relationships existed in the short run.

Practical Implications: The findings of this study have some important implications for market participants and policy makers. The direction of relationship between futures and spot prices showed that in general, the direction of causality was stronger for futures prices to spot prices in case of three commodities namely wheat, castor seed, and jeera, suggesting that futures prices tend to affect spot prices in the short run. In case of wheat, castor seed, and jeera, futures price discovery can play an important role in market decision making for stakeholders in these commodities.