Recipient Organization
UNIV OF IDAHO
875 PERIMETER DRIVE
MOSCOW,ID 83844-9803
Performing Department
Agri Economics & Rural Sociol
Non Technical Summary
Agricultural and food markets have exhibited strong market volatility in recent years. Market volatility has been fueled by rapid economic growth in developing countries, globalization, production, policy and technological shocks, enhanced communication platforms, shifting relationships in the supply chains (i.e.market power), as well as constant changes in consumer preferences. Continuous changes in market condition motivate the evaluation of the role of institutions and tools used for market risk management. Questioning whether these tools (i.e futures and options markets or insurance) are still effective and still provide relevant information to market participants.This project delves into market microstructure evaluating the role of futures and options instruments. As noted by O'Hara (2003), markets have two important functions: liquidity and price discovery. Liquidity refers to the ability to quickly buy and sell an asset without causing large price changes.Market microstructure is the study, design, and regulation of trading mechanisms (Hasbrouck, 2007), looking to understand the process of how the demand and supply of market participants are translated into transactions(Madhavan, 2000), thus is an essential analysis of the quality of the market and its institutions.Recently, trading in commodity futures and options markets became fully electronic and based on the limit order book (LOB). A limit orderis anorderto buy or sell an asset at a specific price or better.The limit order book provides an inventory of the orders with their corresponding prices, volume, and time stamp. As such liquidity is directly observed from this inventory. For commodities, this implies a need for re-evaluation of measurements of market microstructure, as well as an analysis of its impact on market quality and contract performance (i.e. price discovery, hedging, liquidity), as well as the feasibility of new contracts.The literature on market microstructure of commodity futures markets is still in development and has been hampered by lack of data availability(Aidov & Daigler, 2015; Arzandeh & Frank, 2017; Oztekin, 2014). Several measures and factors of liquidity using the limit order book have been developed for financial contracts(Holden, 2014; Litzenberger, Castura, & Gorelick, 2012), however, those do not necessarily apply to agricultural commodity markets because agricultural derivative markets are smaller than financials, and based on very different economic fundamentals.In the literature, liquidity is often synonymous with width, represented by the bid-ask spread(Pennings, Kuiper, Hofstede, & Meulenberg, 1998). However, as identified byKyle (1985) properties of a liquid market include not only width, but also, depth ('the size of an order-flow required to change prices a given amount') and resiliency ('the speed with which prices recover from a random, uninformative shock')(Gould et al. 2013, P. 1710). Recent work on liquidity width for agricultural commodities (under electronic trading), can be found inWang, Garcia and Irwin (2014)andShang, Mallory, & Garcia, (2018). They identified that little is known of the determinants and structure of electronically-traded futures markets. Further, less attention has been paid to market depth and resilience, and virtually no literature exists on options trading. I will examine the association in the informational content between futures and options, looking to identify and disentangle liquidity premia.Within this context, I also would like to touch on related areas of microstructure of commodity markets. For instance, the extent that fundamental information impacts the trading flow. For instance, in recent years, there is evidence of co-movement of commodities including agricultural and energies(Dorfman & Karali, 2014), that raises he question, do cross-market relationships affect the trading flow? As such this project aims to evaluate the association between industrial relationship like the case of soybeans (liquidity spillovers).Since liquidity is a determinant of volatility(Costa Jr, Trujillo-Barrera, & Pennings, 2018; Wang et al., 2014), liquidity spillovers are subsequently of great importance for analyzing market co-movements. The project will evaluate markets with different levels of liquidity, from very liquid markets like crude oil and natural gas, to middle liquidity markets like soybeans, and finally examining thin markets such as ethanol.
Animal Health Component
60%
Research Effort Categories
Basic
20%
Applied
60%
Developmental
20%
Goals / Objectives
This project aims to provide a better understanding of the performance of futures and options markets as tools for commodity price risk under the lens of increased market volatility. I look at determinants and impacts of market volatility in liquidity, institutional changes, and managerial strategies to cope with it. The applications are aimed to be general but also applied to the context of stakeholders in Idaho (i.e. grain and livestock producers, students of the commodity price risk management certificate).To achieve this, the objectives are:1-Evaluate the appropriateness of measures of market liquidity on the dimensions of immediacy, width, market depth and resilience.2-Analyze and measure the extent that liquidity spillovers influence the trading flow and price discovery of markets exhibiting different levels of liquidity and the commonality of liquidity in different industries (extent of the influence on hedging and cross-hedging)3-Provide empirical and theoretical content on how the process of information flows between options and futures are determined. Evaluate how futures and options interactions contribute to price discovery, liquidity, or hedging.4-Generate insights and recommendations on the design current and new futures and options contracts specifications.
Project Methods
Efforts:Outreach: Via conference presentation and conference organization. For instance, I will organize a session on agricultural commodity market microstructure at the European Association of Agricultural Economics (EAAE) meeting in 2020.Evaluation:3/4 publications in peer reviewed journalsWorkshops and blogs disseminating results to the industryOrganization of conference session (EAAE 2020)Proactively involve master students of the applied economics program to consider the option of writing their master thesis in these topics.