In 2002, when the government permitted futures trading on most of the commodities and allowed setting up of national level exchanges, trading in agricultural commodities grew very fast with soy oil, soy bean, mustard seed and chana constituting the major share in 2013. The current study attempts to analyze the price behavior in terms of returns as well as volatility between the spot and futures markets for these four commodities. The study uses a combination of VECM and EGARCH models to analyze the data. The study finds existence of long-term equilibrium relationship between the futures and spot prices, with the futures leading the spot. In the short run, futures returns seem to have a stronger impact on the spot returns in most of the commodities.

Derivatives markets are expected to fulfill the twin objectives of risk transfer and price discovery. Risk transfer mechanism is intended to help the hedgers to transfer their price risk effectively to other market participants willing to assume the same. The effectiveness of this mechanism depends on how efficiently the market fulfills the second objective of price discovery. Price discovery is the process of new information being factored into the prices. The price discovery benefit of futures trading is predicted on the assumption that future prices reflect the combined views of a large number of buyers and sellers, all expressing their perceptions of the future value of some commodity (Fortenbery and Zapata, 1997). Even though both, the futures and spot markets receive the same information at the same time, it is argued that futures market assimilates the information faster for various reasons. According to Tse (1999), futures markets incorporate information more efficiently compared to cash markets due to the inherent leverage, low transaction costs, and lack of short sell restrictions present in futures markets. However, empirical studies have established bidirectional information flow between these two markets, especially in developing markets like India and China. The present study attempts to examine the causality between spot and futures markets of agricultural commodities in India. It also examines the pattern of volatility spillover between these two markets.

In India, commodity derivatives markets became active in 2002, when the government permitted online trading in commodity futures contracts. Since then the market has seen phenomenal growth both in terms of value of trade as well as the volume and number of commodities traded. When the total trade in commodity futures grew at an average rate of 34.24% during 2008-13, the same for the agricultural commodities was 36.15% (Table 1).

Applied Finance Journal, Vector Error Correction Model (VECM), Dow Jones Industrial Average (DJIA), Generalized Autoregressive Conditional Heteroskedasticity (GARCH), Price Discovery, Volatility Spillover, Agricultural Commodity, Futures Market in India.