Endogenous Agricultural Price Fluctuations And The Relationship Between Agricultural Futures And Spot Prices

Speculation refers to the act of forecasting an asset's price trend and taking a position in that asset accordingly in the hope of receiving capital gain due to a correct prediction.Speculation does not only take place in financial markets like stock or bond markets.In fact,some of Chinese agricultural products like garlic have become the targets of speculators gradually.There are even garlic brokers who have similar functions as stock brokers,and financial intermediaries like banks that provide leverage to garlic speculators.After observing the severe speculative activities in Chinese agricultural markets,people naturally blame them for the frequently seen boom-bust cycles in agricultural prices.This paper aims to examine this claim and to explore plausible price stabilization mechanisms.Firstly,this paper builds two nonlinear dynamic models for an agricultural spot market,the baseline model and the modified model.The latter majorly differs from the former in the existence of speculative demand.The modified model is further calibrated with a simulated method of moments(SMM)approach using garlic and ginger price data in China.The comparison of the two theoretical models' numerical results indicates that speculation may indirectly cause endogenous agricultural price fluctuations by facilitating the destabilizing force of farmers' expectation variations.The calibration results suggest that the large price swings of the two agricultural products are not merely caused by traditional supply and demand factors,and are speculative bubbles to some extent.In both ginger market and garlic market,the intensity of speculative activities will be increased when historical speculative gains experience a rise.However,ginger speculators chase past performance more fiercely than garlic speculators.The policy simulations conducted based on the calibrated models show that properly guiding farmers' price expectations may help enhance agricultural price stability.Extreme price swings can be triggered by the joint impact of speculation and farmers' price expectations.Therefore,in these simulations,if garlic farmers and ginger farmers use government-guidance prices to replace their original expectations,simulated price variances of garlic and ginger will be reduced respectively and effectively.Further empirical analysis demonstrates another way to stabilize agricultural prices,launching agricultural futures contracts.In order to investigate and understand the influence of agricultural futures markets on spot prices,this paper constructs a GARCH(1,1)model and a VECM model,and estimates them using spot and futures price data of corn and sugar.The regression results of the GARCH(1,1)model indicate that the introduction of corn or sugar futures significantly decreases the underlying spot price volatility.For either corn or sugar,the coefficient of the dummy variable in the GARCH(1,1)model,representing whether or not the futures contract is introduced,is negative and significant at the 1% level.Moreover,we argue that agricultural futures stabilize spot prices through two channels,decreased speculation in spot markets and the price discovery function.The empirical results of the VECM model confirm the existence of the latter channel: the estimated coefficients of the VECM model,the Granger causality test,and the impulse response function analysis are all in support of the view that corn futures price and sugar futures price can predict the underlying spot prices.This paper contributes to the literature by successfully overcoming challenges in causality faced by the traditional methods that test for agricultural speculative bubbles.This is achieved by establishing and calibrating a structural model,i.e.the modified model.The calibration results actually verify the causality effect of speculative activities on garlic and ginger price volatility.Another major contribution is made by this paper through innovatively pointing out financial tools like agricultural futures can be a good remedy to excess price volatility caused by the financialization of agricultural products.