"Futures Market Failure?" With Aaron Smith, University of California, Davis. Monday, September 19, 4:10 PM to 5:30 PM, 368A Heady Hall.

Aaron Smith is an Associate Professor of Agricultural and Resource Economics at the University of California, Davis, where he has been since 2001. Originally from New Zealand, he earned his PhD in Economics from the University of California, San Diego. His research addresses trading in commodity and financial derivatives markets. Recent project topics include identifying informed traders in commodity futures markets, understanding commodity booms and busts, modeling demand and supply for agricultural commodities, and explaining recent failures of grain futures markets to accurately price the underlying commodity.

Abstract: In a well-functioning futures market, the futures price equals the price of the underlying asset on the expiration date. An unprecedented episode of non-convergence in corn, soybeans, and wheat markets began in late 2005, and with the exception of brief periods, largely persisted until 2010. During this episode, futures contracts expired at prices up to 35 percent greater than the prevailing cash grain price. Using a rational expectations commodity model, we demonstrate how such non-convergence can be produced in equilibrium by the institutional structure of the delivery market. Specifically, we show how a wedge between the price of storing the physical commodity and the cost of carrying the delivery instrument causes non-convergence. This wedge can be conceptualized as the coupon in a present value equation, so our results provide an example of a significant and complex market in which a present value model explains prices.