J. Quant. Econ.

(2018) 16:129–154
https://doi.org/10.1007/s40953-017-0074-7

ORIGINAL ARTICLE

Price Discovery and Efficiency of Indian Agricultural

Commodity Futures Market: An Empirical
Investigation

Sarveshwar Kumar Inani1

Published online: 30 January 2017

© The Indian Econometric Society 2017

Abstract This study examines the price discovery process and relative efficiency of
ten most liquid agricultural commodities’ futures contracts, traded on the largest agri-
cultural commodity exchange of India (National Commodity and Derivative Exchange
Limited). Three different common factor methodologies—component share method
(Gonzalo and Granger in J Bus Econ Stat 13:27–35, 1995), information share method
(Hasbrouck in J Financ 50:1175–1199, 1995), and modified information share method
(Lien and Shrestha in J Futures Mark 29:377–395, 2009)—have been employed to
determine the extent of price discovery contribution by spot and futures markets. The
sample consists of daily data for the period from January 1, 2009 to October 20, 2015.
Stationarity and Cointegration test results reveal that spot and futures prices are inte-
grated and cointegrated for all commodities. The price discovery results show that
the futures market leads the spot market in case of six commodities, i.e., castor seed,
coriander, cottonseed oilcake, soy oil, sugarM and turmeric. Whereas, in the case of
four commodities (chana (chickpea), guar seed, jeera, and mustard seed), price discov-
ery takes place in the spot market. Therefore, it could be inferred that futures market
is more efficient in price discovery of agricultural commodities. Policymakers could
use these results to design futures contracts on other commodities or to plan con-
crete policies to curb speculation without hampering the efficiency of the agricultural
commodity derivatives market.

Keywords Price discovery · Agricultural commodities · Lead-lag relationship ·

Information share · Market efficiency · Futures market

B Sarveshwar Kumar Inani

sarveshwarinani@gmail.com; fpm13006@iiml.ac.in

1 Research Scholar, Finance and Accounting Area, FPM-5, FPM Hostel, Indian Institute
of Management (IIM), Lucknow, Uttar Pradesh 226013, India

123
130 J. Quant. Econ. (2018) 16:129–154

JEL Classification G10 · G13 · G14

1 Introduction

Agriculture sector plays a crucial role in the Indian economy. Almost two third of the
population depends upon agriculture, directly or indirectly, for their livelihood. As per
estimates of Central Statistics Office, agriculture and allied sectors (including agri-
culture, livestock, forestry and fishery) account for 16.1% of the Gross Value Added
during 2014–15 at 2011–12 prices. However, the agriculture sector is highly dependent
on monsoon, which is why Indian economy is termed as the “gamble of monsoon”.
The role of futures contracts on agricultural commodities becomes, even more, sig-
nificant in an economy like India. Agricultural products play a substantial role in the
exports from India. Government intervention in pricing of agricultural commodities
is very high by fixing minimum support prices. Forward Market Commission (FMC)
is the regulator for commodity exchanges in India. FMC was merged to securities and
exchange board of India (SEBI) on September 28, 2015. All the trades in exchanges
are governed by Forward Contracts (Regulation) Act, 1952. The government banned
the commodity trading completely in 1966, due to substantial fluctuations in prices of
essential commodities. However, commodity futures have been reintroduced by the
Government of India in the year 2002. As of now, there are 26 commodity exchanges
in India but the Government of India has recognized only four exchanges as nation-
wide multi-commodity exchanges: (i) National commodity and derivative exchange
(NCDEX); (ii) Multi commodity exchange (MCX) (iii) National multi commodity
exchange (NMCE); and Indian Commodity Exchange (ICEX).
It is very much evident from the literature that futures markets perform two primary
functions, i.e., price discovery and risk management (Garbade and Silber 1983). Man-
ufacturers and farmers are very much concerned about future prices of commodities
and want to manage their risk by hedging. A lot of agricultural commodities are being
traded in India in different national and regional commodity exchanges, but NCDEX is
the leading exchange for agricultural commodities. It is very crucial for an agricultural
economy to have an efficient and liquid futures market for agricultural commodities
for better and efficient price discovery. The term “Price Discovery” has been used
with different contexts in the literature, but for this study price discovery stands for
rapid incorporation of fundamental news in market prices. Hasbrouck (1995) defines
price discovery as “the proportion of the efficient price innovation variance that can
be attributed to that market” which is also termed as information share of that market.
When similar securities have multiple trading venues, then it is very imperative for
traders and market participants to comprehend the price discovery process, i.e., what
is the contribution of each market in the price discovery process?
Thus far, price discovery studies have focused mainly on either the developed coun-
tries or the equity markets only. Studies for commodity market in emerging countries,
like India, are rather few. Therefore, this study, examining price discovery process at
the individual level of agricultural commodities in a leading commodity exchange in
India, would be a timely contribution to the existing literature. This study has four
major motivations. First, the inadequate research in this field. Second, the contradic-

123
J. Quant. Econ. (2018) 16:129–154 131

tory findings regarding efficiency or lead-lag relationship of individual agricultural

commodity futures markets. Third, applying the common factor methodologies to
Indian agricultural commodities and compare the results with the prevailing literature.
Finally, this study would quantify the relative efficiency of spot and futures market
which will offer ease of understanding the complex nature of market efficiency. The
purpose of this paper is to re-examine the lead-lag relation or price discovery process
between spot and futures prices of agricultural commodities with the application of
common factor methods (based on cointegration). It will offer better decision-making
to market participants. Price discovery relationship has significant implications for
market efficiency, policy-making, risk management, and trading strategies.
This study examines the price discovery process in the spot and futures markets for
ten most liquid agricultural commodities like castor seed, chana, coriander, cottonseed
oilcake, guar seed, jeera, mustard seed, soy oil, sugarM, and turmeric being traded
in NCDEX of India. Daily data for the most recent period from January 1, 2009 to
October 20, 2015 have been used. Three different methods of price discovery have
been used. The first measure is based on the permanent-transitory decomposition as
proposed by Gonzalo and Granger (1995). The second metric is information share mea-
sure suggested by Hasbrouck (1995), and the third one is modified information share
measure by Lien and Shrestha (2009) which is the modified version of information
share measure. Stationarity and Cointegration test results reveal that spot and futures
prices are integrated and cointegrated at 5% level of significance, for all commodities.
The price discovery results show that the futures market leads the spot market in case
of six commodities, i.e., castor seed, coriander, cottonseed oilcake, soyoil, sugarM
and turmeric. Whereas, in the case of four commodities [chana (chickpea), guar seed,
jeera, and mustard seed], price discovery takes place in the spot market.
The remainder of the paper is organized as follows: Sect. 2 discusses existing
literature; Sect. 3 explains econometric methodology in brief; Sect. 4 describes the
data used in the study; Sect. 5 deals with empirical findings; Sect. 6 provides a brief
discussion of the results along with limitations; and finally, Sect. 7 concludes with
implications and future scope.

2 Literature Review

Literature regarding price discovery of commodity markets in emerging countries is

very scant. However, there are several studies which examine price discovery process
in commodity markets of developed countries. A detailed survey of price discov-
ery and risk management for agricultural commodities has been done in Tomek and
Peterson (2001), which discusses what academic research can and cannot accomplish
about assisting producers with risk management decisions. Brockman and Tse (1995)
examine price discovery in the case of four Canadian agricultural commodities (canola,
wheat, barley, and oats) by applying information share methodology and the results
show that price discovery occurs in the futures market. Very recently, Figuerola-Ferretti
and Gonzalo (2010) apply component share method to identify the price discovery
relationship between spot and futures of five commodities (aluminium, copper, nickel,
lead, and zinc) from London metal exchange (LME). The findings unravel that futures

123
132 J. Quant. Econ. (2018) 16:129–154

prices are dominant in highly liquid futures markets of four commodities (aluminium,
copper, nickel, and zinc). Peri et al. (2013) investigate price discovery for corn and soy-
abean and the findings highlight that cointegration and causality relationship between
spot and futures prices are dynamic and different sub-periods were having different
causality relationship. There are several studies, specifically for agricultural commodi-
ties, which have examined the market efficiency and unbiasedness of futures market
for prediction of the spot market and have found that futures market is efficient and
performs price discovery function efficiently (McKenzie and Holt 2002; Wang and Ke
2005; Inoue and Hamori 2014).
Literature for price discovery in Indian commodity market is inadequate. In one
of the very recent studies, Lakshmi et al. (2015) explore the nexus between spot and
futures contracts for crude oil and gold; and the results imply that trading volume
of gold futures respond faster to information in market and help to predict gold spot
returns but this is not happening in the case of crude oil. The another study by Joseph
et al. (2014) examines eight commodities traded on MCX and NCDEX and the results
by frequency domain analysis indicate that there exists a strong unidirectional causality
from futures to spot in case of all commodities which reveals that the futures mar-
ket in India is performing its price discovery function efficiently. Arora and Kumar
(2013) investigate the price discovery process of two non-precious metals, copper and
aluminium, and finds that futures market is leading the spot market in discounting
new information in the market. Moreover, Iyer and Pillai (2010), while analyzing six
commodities (copper, gold, silver, chickpeas, nickel, and rubber) in India, find that
price discovery occurs in the futures market in five out of six commodities. Similarly,
Shihabudheen and Padhi (2010) also find that futures prices act as an efficient price
discovery vehicle in five out of six commodities. Pavabutr and Chaihetphon (2010)
also examine the price discovery process between standard and mini gold futures con-
tracts traded on MCX for the period 2003–2007. They find that both standard and mini
futures lead the spot market in price discovery. However, the contribution of standard
futures contracts was higher as compared to mini futures contracts. There are some
studies which have analyzed commodity indices of MCX (Srinivasan 2012; Inoue
and Hamori 2014) and have found that futures market appears efficient and helps in
predicting future spot prices.
There are some studies which have analyzed price discovery process explicitly for
individual agricultural commodities in India. Kumar (2004) examines price discov-
ery function of five agricultural commodities (castor seed, gur, cotton, pepper, and
groundnut) in India and discovers that futures market is performing its price discov-
ery function efficiently. He reveals that spot and futures price series were integrated
which implies the weak form of market efficiency. However, spot and futures prices
were not cointegrated which says that they are not having a long-run association and
futures prices are not unbiased predictors of the future spot prices. These findings
are consistent with an earlier study by Sahadevan (2002a). While analyzing the per-
formance of Indian agricultural commodity futures markets, Naik and Jain (2002)
find that the performance of futures markets varies across commodities, exchanges,
and contracts. They further reveal that the markets are deficient in several aspects but
they have potential for performing the functions of price discovery and risk manage-
ment. On the same line, Easwaran and Ramasundaram (2008) explore the efficiency

123
J. Quant. Econ. (2018) 16:129–154 133

of four agricultural commodities (castor, cotton, pepper, and soya) traded in MCX
and NCDEX in India. They also reveal that the futures market is not performing effi-
cient price discovery function, and it is unable to offer an efficient hedge against the
price risk. They attribute this inefficiency of the futures market to infrequent trad-
ing in exchanges, lack of active participation of trading members, non-awareness of
futures market among the farmers, poor physical delivery in many commodity mar-
kets, the absence of well-developed grading and standardization system, and market
imperfections.
Sahadevan (2002b) outlines the growth constraints and revival policy options
for Indian agricultural commodity markets. He suggests that agricultural commod-
ity futures market in India has limited practical relevance because prices of many
commodities are controlled by government interventions in production, supply, and
distribution. Hence, there is a need of more focused and pragmatic approach from the
government, the regulators, and, the exchanges, to make the agriculture futures mar-
ket a vibrant segment for risk management. Dummu (2009) also finds that commodity
futures markets have made enormous progress in terms of technology, transparency,
and the trading activity after government intervention was removed from a number
of commodities. Moreover, the Abhijit Sen committee (2008), which was set up to
analyze the impact of futures trading on the prices of essential agricultural com-
modities, reports that there is no clear evidence that futures trading has led to either
reduced or increased volatility of spot prices of essential agricultural commodities.
However, the prices of agricultural commodities accelerated after introduction of the
futures trading, but a part of the acceleration may be due to rebound of the past trend
(pre-futures period) in which prices were relatively low due to international down-
turn. Therefore, the price-rise during post-futures period could be a normal cyclical
adjustment. The committee recommends expanding the scope of futures trading with
upgraded regulations. It reveals that Indian commodity market is not able to perform
its risk management function due to high basis risk in most contracts. Moreover,
the efficiency of futures market depends on the efficiency of the spot market, hence,
reforming and integrating spot market should be the top priority. The structure of the
market, contract specifications, and other trading requirements should be simple, so
that farmers can participate in these markets.
The recent studies for agricultural commodities reveal that futures market is efficient
and performs its price discovery function very well. Singh et al. (2009) examine the
efficiency of futures market for some agriculture commodities (important cereals,
pulses, oilseeds, and cash crops), and the results reveal that futures market serves its
price discovery function efficiently for chana, urad, masoor, refined soya oil, jeera, and
kapas, but not for wheat and potato. Therefore, futures markets serve as a risk-shifting
function and can be used for hedging purpose. Elumalai et al. (2009) investigate
the price discovery of three agricultural commodities (pepper, guar seed, and chana)
and the results suggest a unidirectional causality from the futures market to the spot
market for all commodities. Hence, price discovery occurs in the futures market,
which indicates the better hedge efficiency for producers to hedge their price risk
in the futures market. Ali and Gupta (2011) examine the cointegration relationship
and causality between spot and futures prices of 12 agricultural commodities (wheat,
rice, maize, chickpea, black lentil, red lentil, guar seed, pepper, cashew, castor seed,

123
134 J. Quant. Econ. (2018) 16:129–154

soy bean, sugar grade M); and their results suggest that spot and futures prices are
cointegrated in all cases except for wheat and rice. The Granger causality test indicates
that futures markets have stronger ability to predict subsequent spot prices for chickpea,
castor seed, soybean and sugar as compared to maize, black lentil and pepper, where
bi-directional relationships exist in the short-run. Similarly, Sehgal et al. (2012) study
ten agricultural commodities traded on NCDEX (chana (chickpea), guar seeds, soya
bean, kapas, potato agra, turmeric, black pepper, barley, maize and castor seeds), and
reveal that the futures market effectively serves the price discovery function in all of
these commodities. Furthermore, Malhotra and Sharma (2013) also find the leading
role of futures market while analyzing guar seed traded on NCDEX. Shakeel and
Purankar (2014) also examine the lead-lag relation of three commodities (soyabean,
castor seed, and chana (chickpea)) and find a bi-directional causality between spot
and futures without the dominance of any market. In a very recent study, Joseph et al.
(2015) investigate the potential asymmetric causal relationship between the spot and
futures prices of 11 Indian agricultural commodities (soy oil, chana (chickpea), castor
seed, cotton oilcake, mustard seed, soy bean, coriander, turmeric, jeera, pepper, and
wheat). The results indicate that the futures market for agricultural commodities offers
a powerful price discovery function which implies the efficiency of Indian agricultural
commodities’ futures market.
The discussion above shows that Indian commodity market has gained efficiency
over the time. This is the reason that the recent studies show that futures market
is efficient and performing its price discovery function very well. But the earlier
studies, before the year 2008, were giving contradictory results. This revelation is also
manifested in Inoue and Hamori (2014), which investigate the efficiency of commodity
futures in India for different sub-periods. Owing to contradictory findings on the
direction of causality, it seems necessary to re-examine the price discovery process for
agricultural commodities to gain fresh insights. Most of the studies, discussed above,
have used conventional methods to analyze the lead-lag relation between spot and
futures prices. But none of them have used common factor methods which quantify
the relative price discovery contribution of spot and futures markets in price discovery
process. Hence, this study could be considered a timely contribution to fill this gap
of quantification of price discovery contribution in Indian agricultural commodity
market.

3 Methodology

Theoretically, spot and futures prices of any commodity have the same underlying
information set. Therefore, they need to maintain an equilibrium relationship and both
prices should not diverge from each other without bounds to avoid any arbitrage oppor-
tunity. This relationship might be perturbed by market microstructure or demand and
supply of the commodity in short-run, but in long-run they should be identical. The
investigation of this equilibrium is termed as price discovery analysis in literature.
Such investigation could be helpful in examining the role of speculation in the futures
market. If the futures market is dominant in the price discovery process, speculation
might be an important determinant of prices. On the other hand, if the spot market

123
J. Quant. Econ. (2018) 16:129–154 135

is leading the futures market then market fundamentals may be an important deter-
minant of prices (Kaufmann and Ullman 2009, 551). As per unbiased hypothesis,
futures prices are unbiased predictors of future spot prices. Transaction cost hypothe-
sis suggests that a market with lower trading costs will be dominant in price discovery
which is intuitive as well. In general, futures markets have lower transaction costs
(brokerage, etc.) vis-à-vis transaction costs in the spot market. Therefore, the futures
market should be dominant in the price discovery process ideally. Futures markets
impound the information faster, as physical delivery is not required in it and it could
be performed quickly with a little upfront amount (Silvapulle and Moosa 1999). The
methodology section has been divided in two sub-sections to investigate the price dis-
covery process between spot and futures market. First sub-section shows that how spot
and futures prices could be modelled using a vector error correction model (VECM).
Subsequently, sub-section 2 describes three price discovery measures to be utilized in
this study.

3.1 Vector Error Correction Model

In order to obtain the price discovery contribution of each market, this study has
employed three most often used measures. The first measure is component share (here-
after CS) based on the permanent-transitory decomposition as proposed by Gonzalo
and Granger (1995). The second metric is information share (hereafter IS) measure
suggested by Hasbrouck (1995), and the third one is modified information share (here-
after MIS) measure by Lien and Shrestha (2009) which is the modified version of
information share measure. All these metrics rely on the vector error correction model
(VECM).
Theoretically, every asset has an unobserved efficient price which represents the
true value of that asset contingent upon the available public information. But if the
same or similar assets is/are traded in different markets (such as spot and futures), then
prices in different markets have the identical underlying information set or common
efficient price. However, prices in these different market may differ due to market
frictions (e.g. transaction costs, inventory holding costs, etc.). For example, let Pt be
a 2 × 1 vector of spot and futures prices of a commodity such as Pt = (St , Ft )T . Both
spot and futures prices are having two components, one is equal to the efficient price
and the other is a friction component. In this situation, spot and futures prices share
one common stochastic trend in long-run, which is the common efficient price.
The study of price discovery starts with the assumption that when a security trades
in spot and futures markets, observed prices in both markets should be cointegrated.
Hence, before proceeding for computation of price discovery measures, unit root
tests and cointegration tests have been conducted. Augmented Dickey–Fuller test and
Phillips–Perron test have been used for determining the order of integration. When
spot and futures prices are found to be integrated of the same order, Johansen trace and
maximum eigenvalue tests are employed to test for cointegration between spot and
futures prices. Engle–Granger cointegration test is also conducted to identify the one-
to-one cointegration relationship between prices. These all methods are very standard
methods in time-series analysis, hence, have not been described to conserve space.

123
136 J. Quant. Econ. (2018) 16:129–154

After making sure that spot and futures prices are non-stationary and are cointe-
grated with one cointegrating vector β T = (1, −1), that is, the system consists of a
single common stochastic trend (Stock and Watson, 1988). Hence, the spot and futures
prices have the following VECM representation (Engle and Granger 1987):


k 
k
ΔSt = κ S + α S Z t−1 + θ Si ΔFt−i + γ Si ΔSt−i + ε St
i=1 i=1

k 
k
ΔFt = κ F + α F Z t−1 + θ Fi ΔFt−i + γ Fi ΔSt−i + ε Ft (1)
i=1 i=1

Where S and F denotes spot and futures prices respectively, κ S and κ F are inter-
cepts in VECM, α S and α F represents speed of adjustment coefficients (coefficient
of error correction term) of spot and futures prices respectively, θ  s and γ  s are coef-
ficients for lagged returns of futures prices and spot prices respectively, Z t−1 =
(St−1 − C − Ft−1 ), is first difference operator, εt are serially
 2 uncorrelatedresiduals
σ1 ρσ1 σ2
such as εt ∼ N (0,
), and
is covariance matrix i.e. with σ12
ρσ1 σ2 σ22
and σ22 are the variances of VECM residuals of spot and futures prices and ρ is the
contemporaneous correlation between these residuals.

3.2 Price Discovery Measures

This paper computes the contribution of spot and futures market in price discovery
process by three approaches, CS, IS, and MIS. These all measures are related, and the
contribution of price discovery by each of these methods is basically derived from the
VECM in Eq. (1).

3.2.1 Component Share Measure

The CS method (Gonzalo and Granger 1995) measures a market’s contribution to the
common efficient price, with help of speed of adjustment coefficients (α  s) of VECM
as shown in Eq. (1). When spot market dominates the price discovery process, α S will
be smaller in absolute terms as compared to α F which implies that spot market does not
respond to any disequilibrium in prices. Conversely, if α S is larger as compared to α F
in absolute terms, it indicates that spot market strongly responds to any disequilibrium
in spot and futures prices and spot market is a satellite market. The CS for spot and
futures market can be computed using the following measure,

|α F | |α S |
C SS = and C S F = (2)
|α F | + |α S | |α S | + |α F |

123
J. Quant. Econ. (2018) 16:129–154 137

3.2.2 Information Share Measure

IS measure (Hasbrouck 1995) is an alternative to CS method, which defines the price

discovery contribution of a market as the proportion of variance in the common fac-
tor innovations that is attributable to innovations in that market. Hasbrouck (1995)
suggests the vector moving average representation of VECM in Eq. (1), and uses the
Cholesky decomposition of variance-covariance matrix
such as
= F F T to con-
trol the contemporary correlation. Where F is lower triangular matrix and will be such
as:    
f 11 0 σ1 0
F= =  0.5 (3)
f 12 f 22 ρσ2 σ2 1 − ρ 2
Owing to Cholesky factorization, IS for a market turns out to be dependent on the
order of the variables in VECM, which introduces lower and upper bounds of IS
for spot and futures prices. But Baillie et al. (2002) suggest that average of upper
and lower bounds can be used as a reasonable measure to represent price discovery
measure. Furthermore, Baillie et al. (2002, 313, Eq. 9) provides the formulae for easy
computation of price discovery measures by IS, such as:

(ψ1 σ1 + ψ2 ρσ2 )2
IS1 =  ,
(ψ1 σ1 + ψ2 ρσ2 )2 + ψ22 .σ22 1 − ρ 2
 
ψ22 .σ22 1 − ρ 2
IS2 =   (4)
(ψ1 σ1 + ψ2 ρσ2 )2 + ψ22 .σ22 1 − ρ 2

where ψ1 and ψ2 are elements of a vector which is orthogonal to the vector α (obtained
from VECM) such as:

 = α⊥ i.e.  T α = ψ1 α1 + ψ2 α2 = 0 (5)

where α⊥ is a column vector orthogonal to the column vector α of speed of adjustment

T .α = 0.
coefficients, i.e.α⊥

3.2.3 Modified Information Share Measure (MIS)

Lien and Shrestha (2009) propose MIS approach that leads to a unique measure of price
discovery, unlike upper and lower IS bounds. MIS uses eigenvalue decomposition of
correlation matrix instead of covariance matrix
, and the resultant F* matrix will
not be a lower triangular as in IS method. More specifically, the MIS of market i is
defined as:
  2
ψ F∗ i
−1
M I Si = wher e F ∗ = GΛ−1/2 G T V −1 = V GΛ1/2 G T (6)
ψ
ψ T

where ψ and
are as same as in IS method. MIS method is a modified version
of IS method, hence, same notations have been used here.  is a diagonal matrix

123
138 J. Quant. Econ. (2018) 16:129–154

with diagonal elements being the eigenvalues of the innovation correlation matrix,
and G is a matrix in which the columns are the corresponding eigenvectors. V is a
diagonal matrix with diagonal elements being the innovation standard deviations. It
needs to mention that F ∗ is the square root of the variance matrix
such as
=
F ∗ (F ∗ )T . It may be noted that, such factor structure involves a full matrix instead
of a lower triangular matrix, thereby yielding the unique price discovery measures.
Under this new factor structure, Lien and Shrestha (2009) show that the resultant
IS are independent of ordering, which leads to a measure of price discovery that is
order invariant. Three methods of price discovery have been used to find the robust
conclusion regarding price discovery process. These methods have been discussed in
brief to conserve space, however, interested readers may refer to original papers for
detailed discussion.

4 Data

This study covers ten most liquid agricultural commodity futures, being traded on
National commodities and derivatives exchange limited (NCDEX). These ten com-
modities form the Dhaanya index maintained by the NCDEX. Dhaanya, a Sanskrit
word, represents a state of abundance of food grains and prosperity. India is a country
which is highly dependent upon agriculture. This Dhaanya index provides a bench-
mark for the Indian agricultural commodity futures sector. Dhaanya is a value-weighted
index, computed on real time basis using the prices of the ten most liquid agricultural
commodity futures. The composition of Dhaanya is reviewed and rebalanced at a reg-
ular period of three months to include ten most liquid agricultural commodity futures
in the index. The constituents of Dhaanya represent the diverse sub-sectors of Indian
agricultural industry and account for almost 70% of the trading on the NCDEX plat-
form. These commodities are castor seed, chana, coriander, cottonseed oilcake, guar
seed, jeera, mustard seed, soy oil, sugarM, and turmeric.
The dataset consists of daily closing spot and futures for the period ranging from
January 1, 2009 to October 20, 2015 (being the expiry date of that month), however,
for two commodities (Guar seed and Sugar M) the data were available for a lesser
period. The commodities used in the sample, their Bloomberg tickers, contract spec-
ifications, and sample duration is presented in Table 1. This sample duration has not
seen any abnormal event like a crisis, hence, it could be considered a normal period
for examining price discovery phenomenon. Then synchronous price series (for spot
and futures prices) has been prepared by matching the prices on a daily basis. The
data have been obtained from Bloomberg system for these commodities traded on
NCDEX. NCDEX is the leading agricultural commodity index in India. For Castor
seed, Cottonseed oil cake, and Guar seed, spot prices have been downloaded from
official website of NCDEX due to non-availability on Bloomberg. In order to con-
struct continuous futures price series, nearest futures contract prices (consistent with
literature) have been used because these contracts are considered most liquid and most
active contracts. It is well established in the literature that open interest and trading
volume fall drastically for near month futures contracts near expiry date. To preclude
this expiration day effect, near month series has been spliced with next near month

123
 Table 1 Contract specifications with Bloomberg tickers

S.no. NCDEX commodity Bloomberg tickers Basis Unit of Quotation/base Ticksize Sample beginning from
Trading/size value
J. Quant. Econ. (2018) 16:129–154

Spot Futures

1 Castor seed STORDS Comdty C01 Comdty Deesa 10 MT Rs./quintal Re 1 January 1, 2009
2 Chana ARJDDE Comdty H01 Comdty Delhi 10 MT Rs./quintal Re 1 January 1, 2009
3 Coriander ANIYA Comdty POC1 Comdty Kota 10 MT Rs./quintal Re 1 January 1, 2009
4 Cotton seed oil cake CUDCAK Comdty C71 Comdty Akola 10 MT Rs./quintal Re 1 January 1, 2009
5 Guar seed (10 MT) RSEDJD Comdty UDR1 Comdty Jodhpur 10 MT Rs./quintal Re 1 June 5, 2014
6 Jeera ERAUNJ Comdty G01 Comdty Unjha 3 MT Rs./quintal Rs 5 January 1, 2009
7 Mustard seed SEEDJP Comdty M11 Comdty Jaipur 10 MT Rs./quintal Re 1 January 1, 2009
8 Soy Oil OREFID Comdty M71 Comdty Indore 5 MT Rs. /10 Kg 5 Paise January 1, 2009
9 Sugar M GARMDE Comdty MYY1 Comdty Kolhapur 10 MT Rs./quintal Re 1 May 23, 2014
10 Turmeric CFGRNZ Comdty Q61 Comdty Nizamabad 5 MT Rs./quintal Rs. 2 January 1, 2009

Note: Basis stands for the place of spot market prices. Tick size is the minimum price change required, and beginning date of the sample is given and the end date of sample
for each commodity is October 20, 2015

123
139
140 J. Quant. Econ. (2018) 16:129–154

series two days prior to expiry date to make continuous futures price series for all the
commodities.

5 Empirical Findings

5.1 Preliminary Analysis and Descriptive Statistics

Spot and futures prices for all commodities under study have been plotted in Fig. 1. It
reveals that spot and futures prices are moving together, hence, they seem to be cointe-
grated. Different commodities are showing different trends, such as chana (chickpea),
coriander, cotton seed oil cake, and mustard seed are showing a negative trend in
prices, whereas guar seed, soy oil, sugar M, and turmeric is exhibiting negative trends
in prices. However, castor seed and jeera are not showing any clear cut trend in prices.
Descriptive statistics for spot and futures returns, such as mean, standard deviation,
coefficient of variation (CV), Skewness, Kurtosis, Jarque–Bera test results, and number
of observations, for all commodities have been reported in Table 2. Here returns stand
for logarithmic differences of prices, i.e., continuously compounded returns. It could
be observed that average spot and futures returns are either identical or similar in almost
all commodities. For example, average return for spot and futures markets of castor
seed is identical, i.e. 0.0013. Similarly, for chana, guar seed, jeera, mustard seed, and
sugarM, the average returns are identical in spot and futures market. While average
returns are similar in both markets for remaining four commodities. But standard
deviation of returns is higher in futures segment as compared to that of the spot
market for all commodities. Besides, the coefficient of variation (CV) is also higher
in the futures market as compared to that of the spot market for all commodities. It
shows that variation in returns is higher in the futures market, and the futures market is
riskier vis-à-vis spot market. Skewness, kurtosis, and Jarque–Bera test results reveal
that both spot and futures returns are not behaving normally.

5.2 Unit Root Test Results

Augmented Dickey–Fuller (ADF) and Phillips–Perron (PP) unit root tests have been
employed to examine the stationarity of spot and futures prices. Since we are not aware
of true model, both tests have been conducted with two models: (a) with intercept; and
(b) with intercept and trend. These tests have been employed for all commodities at
the level and first differences. Akaike information criterion (AIC) has been used for
optimal lag selection for conducting these tests. ADF test is a parametric approach,
whereas PP test is a non-parametric approach. To conserve space, only PP test results
have been reported in Table 3. ADF tests are also showing the same inferences, hence
not reported but available with the author. Panel A of Table 3 reports the PP test
results for spot prices, and Panel B reports the PP test results for futures prices of all
commodities under study. These findings reveal that order of integration, even at 1%
level of significance, is one for all spot and futures prices which implies that spot and
futures prices are non-stationary at level but becomes stationary at first differences.
For example, in Panel A, t-test statistics for intercept model is −2.76 for castor seed

123
J. Quant. Econ. (2018) 16:129–154 141

Fig. 1 Time series plot for spot and futures prices for all commodities for the entire sample period

at level of prices, which lies in acceptance zone of null hypothesis at 1% level, and the
inference is that the series is non-stationary. Whereas, t-test statistics is −38.83 for
castor seed at first differences of prices, which lies outside acceptance zone of the null
hypothesis and the inference is that the series is stationary. Hence, the overall inference
is that spot prices for castor seed are I(1). A similar conclusion could be inferred for
all the commodities for both models that spot and futures prices are non-stationary
at level but becomes stationary at first differences. After testing for the prerequisite

123
142 J. Quant. Econ. (2018) 16:129–154

Table 2 Descriptive statistics

Commodities Mean SD CV Skewness Kurtosis JB JB-pvalue Observations

Castor seed
Spot 0.0013 0.0425 32.80 32.86 1236.54 102747071 0.00 1616
Futures 0.0013 0.0451 33.93 31.90 1187.69 94776068 0.00 1616
Chana
Spot 0.0005 0.0132 28.06 0.57 6.89 1297 0.00 1897
Futures 0.0005 0.0152 32.72 0.05 8.47 2363 0.00 1897
Coriander
Spot 0.0005 0.0174 34.44 0.52 7.00 1153 0.00 1622
Futures 0.0007 0.0241 36.28 −2.13 45.92 125707 0.00 1622
Cotton seed oil cake
Spot 0.0008 0.0190 24.86 25.18 899.31 64372337 0.00 1917
Futures 0.0007 0.0243 34.92 10.70 395.22 12324534 0.00 1917
Guar seed
Spot −0.0007 0.0234 −31.64 0.22 3.26 3.69 0.16 331
Futures −0.0007 0.0240 −34.65 0.20 2.67 3.58 0.17 331
Jeera
Spot 0.0002 0.0077 32.35 1.12 8.51 2665 0.00 1812
Futures 0.0002 0.0163 67.29 0.43 4.13 151 0.00 1812
Mustard seed
Spot 0.0012 0.0384 33.36 39.66 1666.97 216341669 0.00 1871
Futures 0.0012 0.0407 35.38 36.37 1494.01 173723407 0.00 1871
Soyoil
Spot 0.0001 0.0078 57.96 0.16 10.35 4276 0.00 1897
Futures 0.0002 0.0107 68.32 −0.80 9.76 3817 0.00 1897
SugarM
Spot −0.0004 0.0090 −23.60 1.34 9.30 661 0.00 339
Futures −0.0004 0.0117 −33.23 0.94 10.44 832 0.00 339
Turmeric
Spot 0.0005 0.0174 31.82 0.46 12.94 5730 0.00 1379
Futures 0.0006 0.0319 52.64 −1.67 32.40 50303 0.00 1379

Note: SD indicates standard deviation, CV indicates coefficient of variation, JB indicates Jarque–Bera test
statistics

of non-stationarity of time-series for cointegration test, cointegration test could be

carried out to estimate a long-run relationship between the spot and futures prices.

5.3 Cointegration Test Results

Table 4 reveals the results of cointegration test by three methods: (i) Johansen trace test;
(ii) Johansen maximum eigenvalue test; and (iii) Engle–Granger test. Cointegration test

123
J. Quant. Econ. (2018) 16:129–154 143

Table 3 Unit root test results

With intercept only With intercept and trend

Commodity name At level At first differences Inference At level At first differences Inference

Panel A: spot prices

Castor seed −2.76 −38.83*** I(1) −2.34 −38.87*** I(1)
Chana −0.71 −37.92*** I(1) −1.54 −37.91*** I(1)
Coriander −0.15 −34.24*** I(1) −2.78 −34.26*** I(1)
Cotton seed oilcake −2.36 −41.21*** I(1) −3.10 −41.22*** I(1)
Guarseed −1.42 −16.53*** I(1) −2.29 −16.50*** I(1)
Jeera −1.93 −36.43*** I(1) −1.97 −36.43*** I(1)
Mustard seed −1.12 −42.27*** I(1) −1.70 −42.26*** I(1)
Soyoil −1.54 −33.06*** I(1) −1.46 −33.06*** I(1)
Sugar M −1.24 −18.60*** I(1) −0.73 −18.63*** I(1)
Turmeric −1.61 −27.71*** I(1) −1.89 −27.71*** I(1)
Panel B: futures prices
Castor seed −2.85 −39.06*** I(1) −2.45 −39.10*** I(1)
Chana −0.99 −41.34*** I(1) −1.85 −41.34*** I(1)
Coriander −0.69 −36.83*** I(1) −2.57 −36.83*** I(1)
Cotton seed oilcake −2.60 −43.43*** I(1) −3.44 −43.44*** I(1)
Guarseed −1.50 −15.43*** I(1) −2.31 −15.41*** I(1)
Jeera −2.91 −40.44*** I(1) −2.98 −40.43*** I(1)
Mustard seed −1.17 −43.24*** I(1) −1.80 −43.23*** I(1)
Soyoil −1.73 −41.65*** I(1) −1.71 −41.65*** I(1)
Sugar M −1.35 −17.62*** I(1) 0.13 −17.71*** I(1)
Turmeric −2.18 −35.53*** I(1) −2.35 −35.53*** I(1)

Note: These results are based upon Phillips–Perron test, only t-statistics have been reported in the table.
The critical values for t-statistics are −3.43 and −3.96 for intercept only model, and intercept and trend
model, respectively at 1% level of significance
*** indicates the significance of t-statistics at 1% level of significance

results for all commodities suggest that spot and futures prices are cointegrated at 5%
level of significance. Column 2 and 3 of Table 4 indicate that cointegrating relationship
is one-to-one approximately, for all commodities. For example, for castor seed the
cointegrating vector is (1, −1), whereas for sugarM it is coming to be (1, −0.84).
Therefore, there is a need to test formally whether cointegration vector is one-to-one
or not? For that purpose, this study has used Engle–Granger cointegration method
which answers to this question. Following Engle and Granger (1987) methodology,
the log of spot prices has been regressed on the log of futures prices with an intercept
in the model. If the residuals of this model are stationary (tested with ADF and PP
test), then it could be interpreted that spot and futures prices are cointegrated one-to-
one. The Engle–Granger test results in the last column of Table 4 reveal that spot and
futures prices are cointegrated with one-to-one cointegrating relationship. Trace test
and maximum eigenvalue test statistics have been also reported to test for cointegration

123
 144

123
Table 4 Cointegration test results

Commodities Cointegrating vector Zero cointegrating vector (r = 0) One cointegrating vector (r = 1) Engle–Granger test statistics
Beta of Spot Beta of Futures Trace Max. Eigen Trace Max. Eigen

Castor seed 1 −1.00 77.67** 66.39** 11.21** 9.65** −20.81**

Chana 1 −1.04 63.51** 60.55** 2.85 0.65 −11.87**
Coriander 1 −1.00 55.50** 54.16** 1.29 0.25 −6.53**
Cotton seed oilcake 1 −1.02 109.19** 98.99** 8.58 6.66 −8.04**
Guarseed 1 −0.94 38.86** 36.50** 2.35 2.15 −11.79**
Jeera 1 −1.04 83.48** 76.65** 6.75 6.35 −9.30**
Mustard seed 1 −1.01 58.49** 55.49** 2.95 1.34 −8.13**
Soyoil 1 −1.02 77.40** 74.56** 2.85 2.62 −12.73**
Sugar M 1 −0.84 23.13** 20.79** 1.93 1.68 −3.96**
Turmeric 1 −1.15 29.46** 25.52** 3.93 3.56 −5.02**

Note: Only test statistics have been reported in the table. The critical values for trace statistics are 19.96 and 9.24 (for a model with intercept in cointegrating equation and
VAR) for zero and one cointegrating vector respectively at 5% level of significance. The critical values for maximum eigenvalue test statistics are 14.90 and 8.18 (for a
model with intercept in cointegrating equation and VAR) for zero and one cointegrating vector respectively at 5% level of significance. The critical value for t-statistics for
Engle–Granger test is −2.86 (for intercept only model) at 5% level of significance
** indicates the significance at 5% level of significance
J. Quant. Econ. (2018) 16:129–154
J. Quant. Econ. (2018) 16:129–154 145

relationship between spot and futures prices of all commodities, which also support
the Engle–Granger results, and it could be clearly inferred that spot and futures prices,
for all commodities, are cointegrated at 5% level of significance. For example, trace
test and maximum eigenvalue test statistics are 77.67, and 66.39 for castor seed for
the null hypothesis of zero cointegrating vector (r = 0), and the critical values at 5%
level are 19.96, and 14.90 for these tests, respectively. Therefore, the null hypothesis
could be rejected and it could be concluded that there is one cointegrating vector. The
similar interpretation could be extracted for all securities. Besides, if we have a look
at the trace test and maximum eigenvalue test statistics for the null hypothesis of one
cointegrating vector (r = 1), the null hypothesis of one cointegrating vector cannot be
rejected (except the case of castor seed). Hence, the overall interpretation is that spot
and futures are cointegrated with one-to-one long-run relationship for all commodities.
The cointegrated relationship between spot and futures prices suggests the long-run
market efficiency of Indian agricultural commodity market. Ali and Gupta (2011)
found, while analyzing 12 agriculture commodities, that some commodities (wheat
and rice) were not cointegrated, but this study has discovered that all the commodities
being studied are cointegrated. The reason for no cointegration in their study might
be lower volume in those commodities. Since the current study has included only top
ten most liquid securities, cointegration between spot and futures prices exists for all
commodities as expected.

5.4 Price Discovery Results

The complete results of the VECM, based on Eq. (1), are reported as appendices
(Tables 6 and 7) because complete results are not required for the methodology used
in this study. This study has used three common factor methods based on cointegration.
Some input are required to compute price discovery contributions by these methods.
These inputs, based on VECM in Eq. (1), have been presented in Panel A of Table 5.
These inputs are the speed of adjustment (error correction term) coefficients, the stan-
dard deviations of VECM residuals for spot and futures prices, and the correlation
coefficient between them. The speed of adjustment coefficients are the only inputs
for computation of component share measure of price discovery. Whereas, correlation
and standard deviations of VECM residuals of spot and futures prices is also required
(coupled with the speed of adjustment coefficient) to compute the price discovery
results by information share and modified information share methods. The speed of
adjustment coefficients for castor seed are 0.156, and 0.044 (in absolute terms) for
spot and futures market, respectively. Comparatively higher coefficient for spot mar-
ket indicates that spot market is responding more to the disequilibrium of spot and
futures prices, but the response from futures market is not that much. It suggests that
futures market is agiler or more efficient in reflecting new information in prices vis-à-
vis spot market. Spot market only responds to the price changes in the futures market.
Therefore, we conclude that futures market plays a significant role in price discovery
process for castor seed, and futures prices could be used to predict spot prices. The
speed of adjustment coefficients are comparatively larger for spot market in case of five
commodities, i.e. castor seed, coriander, cottonseed oilcake, soy oil, and sugarM. The

123
146 J. Quant. Econ. (2018) 16:129–154

larger speed of adjustment coefficient for spot market reveals that spot prices respond
more to lagged error correction term, which implies that futures prices are leading spot
prices, and price discovery occurs in the futures market. The opposite interpretation,
spot leads futures, could be drawn for remaining five commodities (chana (chickpea),
guar seed, jeera, mustard seed, and turmeric) where the speed of adjustment coeffi-
cient are larger for futures market as compared to that of the spot market. However,
the conclusion regarding the venue of price discovery could not be based solely upon
the speed of adjustment coefficients. The other inputs, correlation and standard devia-
tions of VECM residuals of spot and futures prices, are also required to compute price
discovery results. These inputs are also shown in Panel A of Table 5. The correlation
between VECM residuals of spot and futures prices varies from minimum 0.14 for
cottonseed oilcake to maximum 0.95 for mustard seed. Standard deviations of VECM
residuals of spot and futures prices is also varying substantially across different com-
modities. But standard deviation for futures market is consistently higher for all the
commodities, which implies more noise trading or speculation activity in the futures
market.
Price discovery results for spot and futures markets have been presented in Panel
B of Table 5. Component share (CS) method results suggest the same interpreta-
tion, based on the speed of adjustment coefficient, as we have discussed in previous
paragraph. But information share (IS) method and modified information share (MIS)
methods, after incorporating the correlation and the standard deviations of VECM
residuals of spot and futures prices, indicate that futures market leads spot market in
case of 6 out of 10 commodities. Overall the price discovery results are consistent
for all commodities by three different methods (except turmeric, in which spot leads
futures by CS method, but futures leads spot by IS and MIS method). Here, only aver-
age value of upper and lower bounds of IS has been reported for brevity. The results
by IS and MIS methods are almost similar for all commodities. The extent of price
discovery by futures market is 78, 93 and 95% for castor seed by CS, IS, and MIS
approach, which implies that futures market leads spot market. The price discovery
contribution by spot market could be computed by subtracting the price discovery
contribution of futures market from one (PD Spot = 1 − PD Futur es ). A market is con-
sidered to be the venue of price discovery, when price discovery contribution of that
market is more than 50%. Overall the futures market leads the spot market in case of
six commodities, i.e., castor seed, coriander, cottonseed oilcake, soy oil, sugarM and
turmeric. Whereas, in case of four commodities (chana (chickpea), guar seed, jeera,
and mustard seed), price discovery takes place in spot market. The price discovery
contribution of spot market is highest for jeera, in which the price discovery shares of
spot market are 81, 62, and 64% by CS, IS, and MIS methods.

6 Discussion of Results and Limitations

If we compare our results with the most recent study of Joseph et al. (2015) for Indian
agriculture commodities, which has studied 11 agricultural commodities, out of which
seven commodities are common with the current study. These common commodities
are soy oil, chana (chickpea), castor seed, cottonseed oil cake, coriander, turmeric,

123
J. Quant. Econ. (2018) 16:129–154 147

Table 5 Inputs for computation of price discovery results and Price discovery results

Commodities Speed of adjustment coefficients Correlation SD of VECM residuals

Spot Futures Spot Futures

Panel A: inputs for computation of price discovery results

Castor seed −0.156*** 0.044 0.24 0.019 0.045
Chana −0.034*** 0.059*** 0.58 0.011 0.015
Coriander −0.033*** 0.017* 0.59 0.016 0.024
Cotton seed oilcake −0.051*** 0.006 0.14 0.018 0.024
Guarseed −0.179* 0.210** 0.81 0.022 0.023
Jeera −0.021*** 0.089*** 0.58 0.007 0.016
Mustard seed −0.031 0.036 0.95 0.038 0.041
Soy oil −0.067*** 0.030 0.65 0.007 0.011
Sugar M −0.083*** −0.005 0.15 0.008 0.012
Turmeric −0.012** 0.021** 0.54 0.016 0.032

Commodities Spot Futures

CS IS MIS CS IS MIS

Panel B: price discovery results

Castor seed 0.22 0.07 0.05 0.78 0.93 0.95
Chana 0.63 0.55 0.57 0.37 0.45 0.43
Coriander 0.35 0.32 0.28 0.65 0.68 0.72
Cotton seed oilcake 0.11 0.03 0.03 0.89 0.97 0.97
Guarseed 0.54 0.51 0.51 0.46 0.49 0.49
Jeera 0.81 0.62 0.64 0.19 0.38 0.36
Mustard seed 0.53 0.50 0.51 0.47 0.50 0.49
Soyoil 0.31 0.32 0.26 0.69 0.68 0.74
Sugar M 0.06 0.01 0.00 0.94 0.99 1.00
Turmeric 0.64 0.48 0.47 0.36 0.52 0.53

Notes: ***, **, and * indicate significance at 1, 5, and 10% level of confidence, respectively. Correlation
is the correlation between VECM residuals of spot and futures prices. SD stands for standard deviation.
Complete VECM results are reported in appendix section (Tables 6 and 7). Bold values in Panel B indicate
the leading role of that market, i.e., the market where price discovery takes place. CS, IS, and MIS stand
for component share, average information share, and modified information share methods

and jeera. Our results are consistent with the findings of Joseph et al. (2015) for all
common commodities except for jeera, and chana (chickpea). The reasons for this
inconsistency might be attributed to different sizes of volume of the commodities in
the futures market in different sample periods. Moreover, our results are also con-
sistent with the findings of Ali and Gupta (2011) for two commodities (castor seed
and sugarM), out of four common commodities. However, our conclusion for chana
(chickpea) and guar seed is different from that of Ali and Gupta (2011). The results may
differ due to many reasons, such as change in government policies, change in futures
market volume, noise trading, speculative trading, different sample durations, and/or

123
148 J. Quant. Econ. (2018) 16:129–154

different methodologies. This study aims to just identify the price discovery contri-
bution of the spot and futures market for ten most liquid agricultural commodities in
the Indian context. Explanation of possible determinants of different price discovery
contributions for different commodities might be a promising research direction in
near future, but it is beyond the scope of this study.
However, this study attempts to investigate the possible reasons to unravel why
futures market is not able to perform its price discovery function in the case of chickpea
and guar seed (i.e., intensively traded agricultural commodities futures contracts). Guar
seed could be a special case here because of its small sample size (from June 5, 2014
to October 20, 2015) as compared to that of other commodities (from January 1, 2009
to October 20, 2015) in the study. The reason for small sample size of guar seed is that
NCDEX restarted the trading in guar seed on September 5, 2013, after forward markets
commission (FMC) lifted the ban. The FMC banned the trading in guar seed futures
contract in March 2012 due to high price volatility,1 and the new guar seed contracts
came with stringent conditions, such as compulsory delivery contracts, additional
margin requirements.2 Such stringent conditions might be the reason that futures
market is not able to perform its price discovery function efficiently. Moreover, for the
first few months (after re-launch of the contract), the volume in guar seed contract was
very low. The low volume increases the impact cost, which might also affect the price
discovery function of the futures market. If we examine the chana, India is the largest
importer of the chana despite being the largest producer in the world.3 The prices of
chana are rising continuously for last two years due to lower production (from 9.53
million tonnes in 2013-14 to 7.17 million tonnes in 2015–16).4 Due to the huge gap
in demand and supply as observed from historical price patterns, the futures trading in
chana was banned5 in June 2016 by securities and exchange board of India (SEBI, the
new regulator of commodity futures market). Hence, it could be inferred that futures
market will perform price discovery only when spot market is efficient and there is
adequate supply of the commodity (either by production or import). Chana, being a
very essential commodity, is highly regulated by the government which might be a
reason that futures market is not able to perform efficiently. Similar reasons could be
attributed to the price discovery results of jeera and mustard seed as well.
To sum up, the empirical results suggest that the market linkages arising from
past innovations are stronger from futures to spot in case of six out of ten securities.
These findings imply that futures market is agiler in the assimilation of information

1 Source: Economic Times, May 14, 2013 [accessed on December 15, 2016] (http://articles.economictimes.
indiatimes.com/2013-05-14/news/39255969_1_guar-gum-guar-seed-additional-delivery-centres).
2 Source: Smart Investor (Business Standard), May 14, 2013 [accessed on December 15,
2016] (http://smartinvestor.business-standard.com/market/story-175974-storydet-After_14_months_of_
ban_trading_in_guar_seed_guar_gum_begins.htm#.WF5-nlN97IU).
3 Source: Official website of NCDEX [accessed on December 15, 2016] (http://www.ncdex.com/
GlobalSearch/Search.aspx?SearchText=CHARJDDEL&SearchTitle=CHANA).
4 Source: Economic Times, Oct 31, 2016 [accessed on December 20, 2016] (http://economictimes.
indiatimes.com/markets/commodities/views/view-its-time-to-bring-back-the-widely-traded-chana-futur
es/articleshow/55149127.cms).
5 Source: Official website of SEBI [accessed on December 20, 2016] (http://www.sebi.gov.in/sebiweb/
home/detail/34084/yes/PR-Trading-in-Chana-futures-on-Commodity-Derivative-Exchanges).

123
J. Quant. Econ. (2018) 16:129–154 149

than the underlying spot market. The findings of common factor methods substantiate
the VECM results for the speed of adjustment coefficients. The plausible reasons for
futures leading spot could be the lower transaction costs, ease of short-selling, and low
initial investment due to inherent leverage in the futures market. Price discovery by
futures market is highest for sugarM (100% by MIS), followed by cottonseed oilcake
(97% by MIS), castor seed (95% by MIS), soyoil (74% by MIS), coriander (72%
by MIS), and turmeric (53% by MIS), respectively. Whereas, price discovery shares
(MIS) by futures market are 49, 49, 43, and 36% for mustard seed, guar seed, chana
(chickpea), and jeera, respectively. Here, it could be observed that price discovery
contribution by futures market is still high, though not dominant, even for the com-
modities where spot market is playing a dominant role. Hence, the futures market is
more efficient in India as compared to the spot market.
Every research has some limitations. The first limitation of this study is the small
sample size of only ten commodities. It is because we have considered only ten most
liquid commodities. If we include less liquid commodities, then the results might not be
as reliable as we are getting the results with highly liquid commodities. Second, only
Indian agricultural commodity market has been considered due to data constraints.
Third, merely contribution of price discovery for spot and futures markets have been
shown, but possible determinants of price discovery have not been discussed. There are
some recent studies (Fricke and Menkhoff 2011; Frijns et al. 2015a, b) which analyse
the impact of macroeconomic news and other market variables (volume, volatility,
etc.) on price discovery process of other markets, but not agriculture commodities’
market. Therefore, it might be a fruitful research agenda in near future.

7 Conclusion and Implications

In this study, we analyse the price discovery in the spot and futures markets for ten most
liquid agricultural commodities like castor seed, chana, coriander, cottonseed oilcake,
guar seed, jeera, mustard seed, soy oil, sugarM, and turmeric being traded in NCDEX
of India. Daily data for the most recent period from January 1, 2009 to October 20,
2015 have been used. Price discovery results, by all three methods employed, indicate
that the futures market leads the spot market in case of six commodities, i.e., castor
seed, coriander, cottonseed oilcake, soy oil, sugarM and turmeric. Whereas, in the
case of four commodities (chana (chickpea), guar seed, jeera, and mustard seed), price
discovery takes place in the spot market. Based on these results, it can be concluded
that despite dominant role of the futures market in the price discovery process, the
price discovery in spot market still exists for some of the commodities. Overall, futures
market performs price discovery function in addition to the hedging facility.
This study contributes to the price discovery literature of commodity market sig-
nificantly, because this study is the first attempt, to the best of knowledge, to analyze
price discovery in Indian agricultural commodity market using common factor meth-
ods, which have never been used previously in the Indian context. Moreover, the results
also show the extent of price discovery contribution by spot and futures markets for
all the commodities under study. Stationarity and Cointegration test results reveal that
spot and futures prices are integrated and cointegrated at 5% level of significance, for

123
150 J. Quant. Econ. (2018) 16:129–154

all commodities under study. It implies that Indian commodity market is efficient in
weak-form and spot and futures prices share a long-run relationship. Moreover, these
findings provide fresh insights for price discovery or lead-lag relationship between
spot and futures prices using very recent data. The present study confirms that in
the majority of the commodities in sample, futures market is more dominant in price
discovery process.
From policy point of view, the futures contracts on agricultural commodities have
contributed significantly to informational efficiency in marketplace. The dominance of
futures market over spot may indicate two things: (i) futures market is more efficient,
and/or ii) more speculative trading in futures market (Silvapulle and Moosa 1999).
Since, our results are showing the extent of price discovery contribution for each mar-
ket, the contribution of futures market over a threshold limit (could be determined by
regulators) could be termed as excess speculation. Then some concrete policies could
be formulated to curb speculation without hampering the efficiency of derivatives mar-
ket. Because stringent measures to control speculation may impact market efficiency
negatively. The results highlight that futures market impounds information quicker vis-
à-vis spot market. Hence, policymakers and regulators should emphasize the reforms
which make the futures market more liquid and more efficient without getting affected
by speculative trading. Overall, the findings are helpful for market participants, man-
ufacturers, traders, wholesalers, policymakers, regulators, and academics to infer the
level of relative efficiency of agricultural commodity futures contracts. Market partic-
ipants would benefit from the results by making effective trading strategies which will
ultimately lead towards financial risk management through arbitrage and hedging.
Since prices play a crucial role in the efficient allocation of limited resources to
various assets, policymakers prefer to have the markets where efficiency is optimal;
and prices reflect the fundamental value. Traders also prefer to trade in a market where
informed trading takes place. The findings of the current study provide the evidence
that futures market is more dominant in price discovery process. Hence, policymakers
should encourage the futures contracts for more agricultural commodities by making
laws and regulations conducive to the development of futures markets. Analyzing
the determinants of price discovery of agricultural commodities in different countries
might be a promising research agenda in near future.

Appendices

123
 Table 6 Complete results of Vector Error Correction Model when first differenced spot price ( Spot) is the dependent variable

Castor seed Chana Coriander Cottonseed oilcake Guarseed Jeera Mustardseed Soyoil SugarM Turmeric

EC Tt−1 −0.156*** −0.034*** −0.033*** −0.051*** −0.179* −0.021*** −0.031 −0.067*** −0.083*** −0.012**
Spott−1 −0.017 −0.106*** −0.004 0.049** −0.212* −0.154*** −0.046 0.007 −0.056 0.133***
Spott−2 −0.334*** −0.045 −0.008 −0.189** −0.063** −0.115 −0.037 −0.016
Spott−3 −0.093*** −0.013 0.027 0.023 0.031
Spott−4 −0.12*** 0.006 0.025 0.052** −0.008
J. Quant. Econ. (2018) 16:129–154

Spott−5 −0.068*** −0.009 0.009 0.04

Spott−6 −0.008 0.039 0.122***
Spott−7 0.001 0.051*
Spott−8 0.083***
Spott−9 0.078***
Futur est−1 −0.084*** 0.455*** 0.198*** 0.039** 0.405*** 0.223*** 0.066 0.246*** 0.182*** 0.128***
Futur est−2 0.717*** −0.048* 0.011 0.111 0.052*** 0.118 0.086*** 0.039**
Futur est−3 0.01 −0.017 0.053*** 0.005 0.04**
Futur est−4 0.287*** −0.033 0.017 −0.038* 0.004
Futur est−5 0.074*** 0.012 0.005 −0.027
Futur est−6 0.105*** 0.014
Futur est−7 0.067*** −0.002
Futur est−8 −0.019
Futur est−9 −0.021

Notes: ***, **, and * indicate significance at 1, 5, and 10% level of confidence, respectively. ECT stands for the error correction term (speed of adjustment coefficient) and
is the first difference operator. Only coefficients of the lagged first difference terms (without standard error and t-statistics) have been reported in the table to conserve space.
Akaike Information Criteria (AIC) has been used to determine the optimal lag length (with maximum 10 lags). Therefore, the above results are showing different lag lengths
for different commodities. This Table shows the results of full VECM when first differenced spot prices ( Spot) is the dependent variable

123
151
 152

Table 7 Complete results of vector error correction model when first differenced futures prices ( Futur es) is the dependent variable

Castor seed Chana Coriander Cottonseed oilcake Guarseed Jeera Mustardseed Soyoil SugarM Turmeric

123
EC Tt−1 0.044 0.059*** 0.017* 0.006 0.21** 0.089*** 0.036 0.03 −0.005 0.021**
Spott−1 0.057 0.056 0.1** 0.002 0.094 0.021 0.019 0.095** −0.065 0.163***
Spott−2 −0.054 −0.002 0.099** −0.045 0.028 −0.052 0.076* 0.021
Spott−3 0.024 0.055 0.099 0.091** 0.02
Spott−4 −0.069 0.055 0.19*** 0.13*** −0.011
Spott−5 −0.014 0.055* 0.055 0.089
Spott−6 0.001 0.031 0.128**
Spott−7 0.007 0.087
Spott−8 0.128*
Spott−9 0.183***
Futur est−1 0.062 0.053* 0.054* 0.013 0.12 0.1*** −0.013 0.011 0.045 0.009
Futur est−2 0.033 −0.022 −0.029 0.038 0.032 0.06 −0.016 −0.029
Futur est−3 −0.051 −0.009 0.031 −0.095*** 0.021
Futur est−4 0.045 −0.039 −0.042 −0.108*** −0.002
Futur est−5 −0.025 0.015 −0.019 −0.039
Futur est−6 0.076 −0.009 −0.072**
Futur est−7 0.02 −0.038
Futur est−8 −0.004
Futur est−9 −0.077**

Notes: ***, **, and * indicate significance at 1, 5, and 10% level of confidence, respectively. ECT stands for the error correction term (Speed of adjustment coefficient) and
is the first difference operator. Only coefficients of the lagged first difference terms (without standard error and t-statistics) have been reported in the table to conserve space.
Akaike Information Criteria (AIC) has been used to determine the optimal lag length (with maximum 10 lags). Therefore, the above results are showing different lag lengths
for different commodities. This Table shows the results of full VECM when first differenced futures prices ( Futur es) is the dependent variable
J. Quant. Econ. (2018) 16:129–154
J. Quant. Econ. (2018) 16:129–154 153

References
Ali, Jabir, and Kriti Bardhan Gupta. 2011. Efficiency in agricultural commodity futures markets in India:
Evidence from cointegration and causality tests. Agricultural Finance Review 71: 162–178. doi:10.
1108/00021461111152555.
Arora, Sunita, and Narender Kumar. 2013. Role of futures market in price discovery. Decision (0304-0941)
40: 165–179. doi:10.1007/s40622-013-0019-8.
Baillie, Richard T., G. Geoffrey Booth, Yiuman Tse, and Tatyana Zabotina. 2002. Price discovery and com-
mon factor models. Journal of Financial Markets 5: 309–321. doi:10.1016/S1386-4181(02)00027-
7.
Brockman, Paul, and Yiuman Tse. 1995. Information shares in Canadian agricultural cash and futures
markets. Applied Economics Letters 2: 335–338. doi:10.1080/758518983.
Dummu, Tata Rao. 2009. Commodity futures markets in India: its impact on production and prices. Indian
Journal of Agricultural Economics 64: 333–356.
Easwaran, R.Salvadi, and P. Ramasundaram. 2008. Whether commodity futures market in agriculture is
efficient in price discovery?—An econometric analysis. Agricultural Economics Research Review 21:
337–344.
Elumalai, K., N. Rangasamy, and R.K. Sharma. 2009. Price discovery in India’s agricultural commodity
futures markets. Indian Journal of Agricultural Economics 64: 315–323.
Engle, Robert F., and Clive W.J. Granger. 1987. Co-integration and error correction: representation, esti-
mation, and testing. Econometrica: journal of the Econometric Society 55: 251–276.
Figuerola-Ferretti, Isabel, and Jesús Gonzalo. 2010. Modelling and measuring price discovery in commod-
ity markets. Journal of Econometrics 158. Twenty Years of Cointegration: 95–107. doi:10.1016/j.
jeconom.2010.03.013.
Fricke, Christoph, and Lukas Menkhoff. 2011. Does the “Bund” dominate price discovery in Euro bond
futures? Examining information shares. Journal of Banking & Finance 35: 1057–1072. doi:10.1016/
j.jbankfin.2010.09.022.
Frijns, Bart, Aaron Gilbert, and Alireza Tourani-Rad. 2015. The determinants of price discovery: Evidence
from US-Canadian cross-listed shares. Journal of Banking & Finance 59: 457–468. doi:10.1016/j.
jbankfin.2015.07.011.
Frijns, Bart, Ivan Indriawan, and Alireza Tourani-Rad. 2015. Macroeconomic news announcements and
price discovery: Evidence from Canadian-U.S. cross-listed firms. Journal of Empirical Finance 32:
35–48. doi:10.1016/j.jempfin.2014.05.001.
Garbade, Kenneth D., and William L. Silber. 1983. Price movements and price discovery in futures and
cash markets. The Review of Economics and Statistics 65: 289–297. doi:10.2307/1924495.
Gonzalo, Jesus, and Clive Granger. 1995. Estimation of common long-memory components in cointe-
grated systems. Journal of Business & Economic Statistics 13: 27–35. doi:10.1080/07350015.1995.
10524576.
Hasbrouck, Joel. 1995. One security, many markets: determining the contributions to price discovery. The
Journal of Finance 50: 1175–1199. doi:10.1111/j.1540-6261.1995.tb04054.x.
Inoue, Takeshi, and Shigeyuki Hamori. 2014. Market efficiency of commodity futures in India. Applied
Economics Letters 21: 522–527. doi:10.1080/13504851.2013.872751.
Iyer, Vishwanathan, and Archana Pillai. 2010. Price discovery and convergence in the Indian commodities
market. Indian Growth and Development Review 3: 53–61. doi:10.1108/17538251011035873.
Joseph, Anto, K.G. Suresh, and Garima Sisodia. 2015. Is the causal nexus between agricultural commodity
futures and spot prices asymmetric? Evidence from India. Theoretical Economics Letters 5: 285–295.
doi:10.4236/tel.2015.52034.
Joseph, Anto, Garima Sisodia, and Aviral Kumar Tiwari. 2014. A frequency domain causality investigation
between futures and spot prices of Indian commodity markets. Economic Modelling 40: 250–258.
doi:10.1016/j.econmod.2014.04.019.
Kaufmann, Robert K., and Ben Ullman. 2009. Oil prices, speculation, and fundamentals: Interpreting causal
relations among spot and futures prices. Energy Economics 31: 550–558. doi:10.1016/j.eneco.2009.
01.013.
Kumar, Sunil. 2004. Price discovery and market efficiency: Evidence from agricultural commodities futures
markets. South Asian Journal of Management 11: 32–47.

123
154 J. Quant. Econ. (2018) 16:129–154

Lakshmi, P., S. Visalakshmi, and S. Padmavathy. 2015. Exploring the nexus between futures contracts and
spot returns in the Indian commodity market. International Journal of Indian Culture and Business
Management 10: 306–317. doi:10.1504/IJICBM.2015.068493.
Lien, Donald, and Keshab Shrestha. 2009. A new information share measure. Journal of Futures Markets
29: 377–395. doi:10.1002/fut.20356.
Malhotra, Meenakshi, and Dinesh Kumar Sharma. 2013. Efficiency of guar seed futures market in India:
An empirical study. IUP Journal of Applied Finance 19: 45–63.
McKenzie, Andrew M., and Matthew T. Holt. 2002. Market efficiency in agricultural futures markets.
Applied Economics 34: 1519–1532. doi:10.1080/00036840110102761.
Naik, Gopal, and Sudhir Kumar Jain. 2002. Indian agricultural commodity futures markets: A performance
survey. Economic and Political Weekly 37: 3161–3173.
Pavabutr, Pantisa, and Piyamas Chaihetphon. 2010. Price discovery in the Indian gold futures market.
Journal of Economics & Finance 34: 455–467. doi:10.1007/s12197-008-9068-9.
Peri, Massimo, Lucia Baldi, and Daniela Vandone. 2013. Price discovery in commodity markets. Applied
Economics Letters 20: 397–403. doi:10.1080/13504851.2012.709590.
Sahadevan, K.G. 2002a. Price discovery, return and market conditions: Evidence from commodity futures
markets. The ICFAI Journal of Applied Finance 8: 25–39.
Sahadevan, K.G. 2002b. Sagging agricultural commodity exchanges: Growth constraints and revival policy
options. Economic and Political Weekly 37: 3153–3160.
Sehgal, Sanjay, and Dr. Namita Rajput, and Rajeev Kumar Dua. 2012. Price Discovery in Indian Agricultural
Commodity Markets. International Journal of Accounting and Financial Reporting 2. doi:10.5296/
ijafr.v2i2.2224.
Sen, Abhijit. 2008. Report of the expert committee to study the impact of futures trading on agricultural
commodity prices. Government of India: Ministry of Consumer Affairs.
Shakeel, Moonis, and Shriram Purankar. 2014. Price discovery mechanism of spot and futures market in
India: A case of selected Agri commodities. International Research Journal of Business and Manage-
ment 8: 50–61.
Shihabudheen, M.T., and Puja Padhi. 2010. Price discovery and volatility spillover effect in Indian com-
modity market. Indian Journal of Agricultural Economics 65: 101–117.
Silvapulle, Param, and Imad A. Moosa. 1999. The relationship between spot and futures prices: Evi-
dence from the crude oil market. Journal of Futures Markets 19: 175–193. doi:10.1002/(SICI)1096-
9934(199904)19:2<175::AID-FUT3>3.0.CO;2-H.
Singh, N.P., V. Shunmugam, and S. Garg. 2009. How efficient are futures market operations in mitigating
price risk? An explorative analysis. Indian Journal of Agricultural Economics 64: 324–332.
Srinivasan, P. 2012. Price discovery and volatility spillovers in Indian spot-futures commodity market. IUP
Journal of Behavioral Finance 9: 70–85.
Tomek, William G., and Hikaru Hanawa Peterson. 2001. Risk management in agricultural markets: A
review. Journal of Futures Markets 21: 953–985. doi:10.1002/fut.2004.
Wang, H.Holly, and Bingfan Ke. 2005. Efficiency tests of agricultural commodity futures markets in China.
Australian Journal of Agricultural and Resource Economics 49: 125–141. doi:10.1111/j.1467-8489.
2005.00283.x.

123