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The IUP Journal of Applied Economics
Efficiency of Futures Market in India: Evidence from Agricultural Commodities
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The study aims at examining the efficiency of futures market with a sample of 11 commodities traded on National Commodity and Derivatives Exchange Limited (NCDEX). Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) tests are applied for testing stationarity and order of integration of both spot and futures market. Zivot-Andrews test of unit root is also applied to ensure reliable results in the event of structural break. Stationarity in spot and futures series at level is observed in case of three commodities, viz., barely, jeera and soybean, and non-stationary at level and stationarity in return series is observed in the case of the remaining eight commodities. To test the cointegrating relationship between both the markets, Johansen test of cointegration is used and finally to observe the direction of causality, Granger causality test is applied. There is evidence of cointegrating relationship indicating the presence of long-run relationship between spot and futures market in eight agricultural commodities. There is also evidence of futures Granger causing spot in the case of six commodities, i.e., barley, castor seed, cotton seed oilcake, gur, mustard seed and refined soya oil. However, there is evidence of bidirectional relationship in the case of remaining five commodities; coriander, jeera, soybean, sugar M grade and wheat. As a whole, it is observed that agricultural commodity futures market is efficient in India.

 
 
 

Although commodity derivatives trading in India was initiated in 1875 with the formation of Bombay Cotton Trade Association Ltd., organized trading in commodities commenced in 2003 with the launch of three national level electronic exchanges, namely, Multi Commodity Exchange of India Limited, National Commodity and Derivatives Exchange Limited, and National Multi Commodity Exchange of India Limited. In India, there are six national commodity exchanges, i.e., Multi Commodity Exchange of India Limited (MCX), National Commodity and Derivatives Exchange Limited (NCDEX), Mumbai, National Multi Commodity Exchange of India Limited (NMCE), Ahmedabad, Indian Commodity Exchange (ICEX), New Delhi, ACE Derivatives and Commodity Exchange Limited, Mumbai and Universal Commodity Exchange Limited (UCX), Navi Mumbai. 99.88% of total trading comes from these six exchanges and the remaining trading takes place in 24 regional commodity exchanges which were existent even before the formation of national level exchanges. However, most of them have hardly had any trading for the last 10 years. Among national level exchanges, MCX and NCDEX lead in market share. 85% of MCX’s total trading business comes from gold, silver, copper and crude oil and a majority of agricultural and metal commodities like refined soya oil, guar seed, and soy bean trade on NCDEX. As on March 31, 2016, NCDEX traded in 27 commodities, of which 21 are agricultural commodities, three bullion commodities, two metal and one is in energy sector. As per the reports by Mint, agricultural commodities contribute 98.6% of the NCDEX turnover, while bullion contributes 1.4%. Hence, the study considers select agricultural commodities traded on NCDEX for testing efficiency of commodity futures market in India. In India, as of now only futures and forwards are available on commodities and options are not yet operational. On September 28, 2016, Capital Market Regulator, Securities and Exchange Board of India (SEBI) permitted commodity derivatives exchanges to introduce option contracts on commodity exchanges to facilitate active participation by a good number of players and to increase the liquidity in commodities market. This move came exactly a year after the former commodity markets regulator, the Forward Markets Commission was merged with SEBI.

Commodity derivatives are expected to perform two economically significant functions—price discovery and risk management. The presence of different players like hedgers, speculators and arbitragers ensures better price discovery in futures markets. Speculators usually act as counterparties to hedgers thereby helping them in managing the risk. Arbitragers in an attempt to gain from the advantage of mispricing help in better price discovery. The survey with brokers by Gupta et al. (2016) reveals that there is a significant contribution of high net worth individuals to trading volume of commodity derivatives. They also opine that all commodity futures, except energy futures, perform price discovery and hedging functions effectively, as energy commodities are the most volatile commodities. Bose (2008) argues that commodity futures help risk allocation across investors, firms and small producers and reduce the cost of diversifying portfolios.

Commodity exchanges act as centralized platforms for buyers and sellers to undertake transactions with or without physical commodities, under a set of predetermined rules and regulations. Commodity exchanges are expected to contribute to market development through reduced transaction costs, improved price discovery and reduced risks. This is because, a centralized location helps in reducing the cost involved in identifying counterparties and physical inspection of product quality. However, in a few countries, exchanges could not perform this function effectively due to government interventions. Trading in exchange traded equity futures which was introduced in 2000 has grown in leaps and bounds. However, trading in commodity futures which was introduced in 2004, just four years after the launch of equity futures, is still in its nascent phase due to various complexities. Hence, the study attempts to examine the efficiency of futures market in select commodities in India.

Market efficiency implies the speed and the accuracy with which information gets reflected in asset prices. With the introduction of futures, the same commodity is available for trading in both spot and futures segment. The question in this case is which market absorbs information faster. In a perfect world, both the markets respond to information simultaneously. This requires participation of different players in commodity markets like farmers/producers, intermediaries, wholesalers, consumers, investors, etc. However, in an imperfect world, one market may lead another market due to the differences in characteristics like cost, liquidity, leverage, etc. A general perception is that futures lead in price discovery due to its associated low-cost advantages, as speculators and other informed investors take futures market as a platform to reflect their viewpoint. A major problem in India is that farmers/producers who undertake cultivation are not educated about commodity trading on organized exchanges. Consequently, commodity markets are dominated by speculators and brokers resulting in excessive speculation which in turn requires frequent intervention by the government in terms of imposing ban on trading. It may lead to inefficient performance of futures market. In this context, the study is an attempt to measure the efficiency of the commodity futures market in price discovery. For that, the study initially examines if there is any cointegrating relationship between both spot and futures markets of select agricultural commodities. Once cointegration between spot and futures is confirmed, the study also observes the direction of relationship between spot and futures market. In other words, it examines the direction of causality between both the markets.

 
 
 

Applied Economics Jouranl, Stationarity of Commodity Futures and Spot Series, Granger Causality Test, Efficiency of Futures Market in India