Are commodity markets efficient? — A critical review of the literature
1.0 Introduction
Previously, the efficiency of the capital market did not attract too much theoretical attention. Because the traditional microeconomic theory holds that the capital market is more in line with the characteristics of the perfectly competitive market, such as many buyers and sellers, product quality, etc., so the capital market is efficient. This view does not be changed until the efficient market hypothesis. As the securities market is the most representative of all capital markets, scholars are concerned about the capital market issues are focused on the securities market.
Many scholars directly on the capital market efficiency research results applied to the futures market research. Direct application of capital market efficiency research results will ignore the futures market and the capital market in the function and role of the difference, there are serious limitations. From the market function point of view, the basic function of the capital market is to achieve effective transfer of funds between borrowers. However, the basic function of the futures market is to achieve the risk of transfer and price discovery, rather than through the futures market directly to achieve resource allocation. Therefore, I think it is necessary to understand the efficiency of the futures market in a broader perspective. Futures market efficiency is not only refers to the futures price allocation efficiency and futures market operating efficiency, but also can be reflected in the functional efficiency of the futures market.
The efficiency of the futures market can also be reflected in the transfer of the spot market risk. The risk of the spot market comes from the volatility of the price, so the price fluctuation becomes a cost of economic activity. Price risk will affect the continuity of production. The transfer of corporate risk can reduce the risk of financing, help to reduce the company's financing costs, increase the company's funds. Therefore, the efficiency of the futures market in terms of risk transfer can be reflected by the efficiency of hedging.
2. The Relevant theory
The theory of market effectiveness has been around for a long time. Bachelier put forward the random walk hypothesis in his paper, that is, the trend of goods prices are random and cannot be predicted. Kendall systematically studies the randomness of stock prices and returns and suggests that stock prices follow a random walk rule.
Since Fama (1970) put forward the efficient market hypothesis, it became the theoretical cornerstone of the efficiency of capital market research (including the commodity markets). Fama (1970) considers that the efficient market is a market that fully reflects all available information. To be precise, the market is valid for this information if the stock market manager exposes a group of information to all participants in the market, the stock price is not affected, and the stock does not fluctuate abnormally. It shows that if the traders use this information, the trader cannot get excess profits, he can only get normal profits. Because before this information be published, the market price has accurately and fully reflected this information.
Based on the information reflected in the price, Fama divides the market efficiency into three levels, weak form efficiency, semi-strong form efficiency and strong form efficiency. If the current market price is sufficiently responsive to all information and all available public information, it is also sensitive to non-public information and can immediately reflect all publicly or non-public information that the market price adequately reflects all Relative information, this market is called a strong and effective market. If the current market price not only fully reflects the historical prices contained in the information, but also fully reflects all the open and available information, this market is called semi-strong and effective market. If the current market has fully reflected all the information contained in historical prices, it is said that the market is a weak and effective market. Efficient market hypothesis holds that if the market price fully reflects all the information obtained, the market can be called an effective market. The greater the effectiveness of the market, the greater the market liquidity, the market price will be more authoritative and competitive and the market mechanism operation will be more efficient.
Efficient market hypothesis is proposed for the capital market, it can also be applied to the futures market. Based on strong and semi-strong tests are difficult to conduct empirical analysis, so far most of the research focused on weak testing. First one, the price of futures market can not fully reflect all the relative information, some information is missing, which affect the efficiency of the market. This is mainly due to the lack of participation in the futures market, there are some people who hold important information and they do not participate in futures trading. Therefore, the price of futures can not reflect this information. This situation mainly exist in the
beginning of futures markets because of the bad fluidity of markets. Second one, the futures markets can not accurately reflect the all relative information. This is mainly exist in a excessive speculation market, the prices reflect the fake information.
Other scholars have suggested other ways to test the difference between commodity market efficiency and futures price forecast. Fama (1991) proposed the use of arbitrage to test the efficiency of commodity markets. The basic theory of the method is that if the futures market and the spot market balance, there is no arbitrage between the two markets, the market is effective. Rendleman & Carabini (1979) established a non-arbitrage equilibrium model that, by testing, confirms whether arbitrage opportunities exist between stock and futures markets to verify market efficiency. The results show that there is a clear opportunity between the two markets if the transaction costs are ignored, and there is no obvious arbitrage benefit if the transaction costs are taken into account. Therefore, they believe that the market should not be considered as inefficient.
3. Relevant empirical evidences
Before Fama put forward the concept of efficient market hypothesis, there are a lot of scholars have done a lot of empirical research on the efficiency of the futures market. At the beginning, the scholars think that the efficiency of the futures market will show different characteristics in different periods, which can be reflected a gradual progress of the process of mature markets. Here we take the American corn futures market as an example, Larson (1960) earliest applied the time series analysis method to study the daily closing price of corn futures prices from 1949 to 1958. He finds that the changes in corn futures prices were randomly changing, therefore, it can be considered that the corn futures market is weak form efficiency.
In addition, there are many early studies support the futures market efficiency hypothesis. In an efficient futures market the futures price are characterized by random fluctuations with the changing of time which means that futures prices can reflect all the information that the participants are available to get. Fama (1976) and Cornell (1977) prove that futures price changes follow the random walk process to support the futures market can meet the efficient market hypothesis. Pretez (1975) studies the wool future market in the Sydney Futures Exchange, according to the closing price data from 1966 to 1972, the test results show that wool future market prices do not have a correlation which means wool future market is weak form efficiency.
By the 1980s, Bigman (1983) study the maize, grain and soybean futures prices by using empirical study on the efficiency, demonstrating that the futures market is weak form efficiency.
However, with the deepening of research, many scholars have also found some evidences that the futures market is inefficient. Stevenson (1970) analyzed the maize and soybean futures markets from 1951 to 1668 by using probability distributions, run-length tests, sequence-related statistical methods and filtering rules, he finds that the investors can obtain a certain investment strategy to obtain profits. Therefore, it deny the assumption that the futures market is weak form efficiency. Weston (1985) studies the gold futures markets in the New York Metal Exchange, the Winnipeg Futures Exchange and Sydney Futures Exchange by using run test, he found inefficient factors in gold future markets.
There are more arguments on the efficiency of commodity markets. Roll (1972) considers that commodity market is inefficient after examining the commodity price index because of significant serial correlations of its returns. Danthine (1977) objected to such claims that the violation of the standard mart condition did not mean that the commodity spot market had a risk aversion and insufficient arbitrage opportunities. Gjolberg (1985) researches oil spot prices at the Rotterdam market, he does not agree the market efficiency hypothesis and he constructs a profitable trading rule for daily, weekly and monthly price changes.
Lately, Tabak and Cajueiro (2007) analyze the efficiency of Brent and WTI crude oil by using the rescaled range analysis and they give the evidence that commodity markets are becoming more and more efficient. Alvarez-Ramirez (2008) thinks that in the long-term, the commodity markets are efficient, but in short-term, it is not. Wang and liu (2010) further put forward that the evolution of efficiency. Therefore, the scholars have noted that the efficiency of commodity market is related to the length of time.
Zunino (2011) apply information theory methods to the commodity markets. This method allow them to rank the silver, copper and cotton to be the most efficient commodities. Wang (2011) apply the multifractal detrended fluctuation analysis to the gold market, and they find that the gold markets are becoming more efficient after 2001. Kim (2011) applies the random matrix theory and network analysis, he points out that commodity markets are well decoupled except for oil and gold showing signs of inefficiency.
Lee and Lee (2009) studied four energy commodities – coal, oil, gas and electricity – using panel data platform testing to find that no market for research was effective in a strictly stable sense. Lean et al. (2010) studied WTI crude oil spot and futures prices, using mean variance and stochastic advantage methods, found that there is no arbitrage between the spot and futures prices, and for each sub-period and key events, found to be robust. Narayan et al. (2010) studied the long-term relationship between gold and oil spot and futures prices. They found that investors use the gold market to hedge inflation, and our goal is more important is the crude oil market forecast gold market, and vice versa, means inefficient.
With the deepening of the study, more and more scholars have realized that the asset prices do not meet the random walk may not be a way to determine the efficiency of market. Leroy (1973) and Lucas(1978) construct the model separately to prove EMH is established, the price fully reflects all the available information does not always follow the price of the order of whether to follow the random walk.
Therefore, the scholars do a variety of empirical tests by whether the future price is an unbiased prediction of spot price, whether there is an abnormal phenomenon in the futures market and whether there are fractal market characteristics of the futures market.
In these selected papers, it is clear that there is a lot of results in the analysis of commodity market efficiency. However, research usually focuses on single (or one-pair) efficiency measures to test whether a particular market is effective. Scholars did not agree on the efficiency of commodity markets, but most of the evidence above proved that the efficiency of the commodity market was very low.
4.Conclusion
This essay reviewed the relative theory and relative empirical evidences of the efficiency of commodity market. It is obvious that scholars and the futures market limited test perspective more and more wide. In all the literature, mainly around the effective market hypothesis of the weak and semi-strong two tests to start.
However, scholars all think that market price as long as the realization of a state is called the efficient market, and vice versa that the market is invalid. The development of the theory has gone through the stages of random walk theory, effective market hypothesis and price predictable value analysis. The empirical evidence of the subject suggests that the assessment of commodity economic benefits is influenced by a number of key factors, including test factors, commodity categories, and the duration of the secret period.
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