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The IUP Journal of Applied Finance
Does Derivative Trading Facilitate Price Discovery and Risk Management?
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As it is quite obvious that agriculture is a seasonal industry, risk is at all times inbuilt in the trading of commodities. Trading of commodity futures assists in price discovery and management of risk, which as a result reduces the unpredictability in the price of the fundamental commodity. In this paper, an endeavor has been made to scrutinize the relationship between price discovery and prevarication efficiency of commodity futures for five agricultural commodities chosen from diverse categories. The outcomes stated in this paper are essentially projected to catch the attention of policy makers for policy making and the hedgers to invent prevarication tactics. This paper intends to recognize whether futures prices facilitate determination of spot prices or vice versa. The mandatory data for this study was collected from the National Commodity and Derivatives Exchange (NCDEX) of India. The study derived implications using Augmented Dickey Fuller test, Granger Causality test, Johansen cointegration test and estimating the variance of the hedged and unhedged portfolio. The results of the study convincingly point out that futures prices do serve the function of price discovery proficiently for spot prices. The outcomes of the study disclose that commodity futures exchange provides a proficient hedge against the risk emerging from unpredictable prices of chosen commodities.

 
 
 

In Indian economy, where agriculture plays a vital role, the main concern of the producers, processors and dealers, in addition to the consumers, is the unsteadiness of commodity prices. Farmersí direct contact to price variations makes it excessively precarious for many farmers to invest in otherwise lucrative activities. There are a variety of ways to cope with this problem. Apart from escalating the steadiness of the market, the activities of various performers in the farm sector can better be supervised in an environment of unhinged prices with the aid of commodity exchanges. In the perspective of India, commodity exchanges, as defined in a narrow sense, are centers where futures trade is structured. Risk-shifting function is carried out by these exchanges. Futures markets also perform a chief role in price discovery apart from being a medium for risk shifting among hedgers and from hedgers to speculators.

In derivatives market, various instruments are traded which include financial instruments such as futures and forward contracts, options and swaps and physical instruments like inventories. The most important instrument among them is the futures contract which provides significant information about cash and storage markets. Fleming et al. (1996) reported that price discovery, hedging, financing, liquidity, price stabilization, encouraging competition, increasing efficiency, inherent leverage, low transaction costs, and lack of short sale restrictions as well as fulfilling desires of speculators are some of the prime economic functions of the futures. According to Tse (1999), prices are first updated in the futures market, which thus serves as a price discovery vehicle for investors.

 
 
 

Applied Finance Journal, Seasonal industry, Management of risk, Fundamental commodity, Evidence from Tunisian Revolution, Impact of Political Instability, Prevarication tactics.