Modelling and testing the efficiency of price discovery in live cattle markets: A linear systems state space approach
Abstract
The efficiency of live fed cattle markets in the U.S. has been disputed for various reasons. Some of the most common arguments against efficiency hinge on the monopsonistic structure of the beefpacking industry, asymmetric information as a result of the reduction in use of terminal and auction markets, and the introduction of forward contracts and other vertical linkages. Various measures and methods have been used to assess the efficiency of the live cattle markets. Many of the results have been inconclusive. The weak-form of the Efficient Market Hypothesis has not been tested directly with regard to live cattle markets. Yet this criteria can be tested directly via time series methods. Certain time series properties must hold in order for weak-form efficiency to be found. In fact, the central necessary condition is cointegration of the system of regional cattle prices. In addition, the sufficient condition requires that positive profits cannot be captured through speculation and arbitrage. Cointegration necessarily implies the ability to forecast relative prices. This result suggests a direct (sufficient) test of weak-form efficiency by creating a trading rule from the forecasts. If revenue from this speculative rule exceeds transactions costs and yields positive utility, the efficient market hypothesis fails. This thesis uses the linear state space representation due to Aoki (1987) to model weekly live cattle prices from nineteen regional cattle markets, test necessary and sufficient conditions for the Efficient Market Hypothesis, and determine market factors related to disequilibria in regional markets. The results of the model formulation suggested that cointegration of the multivariate system could not be rejected. In addition, the forecasts from the model were very accurate, out-of-sample. Most importantly, it was shown that, not only could a rule be formulated that would yield positive profits, but a risk averse agent would find the riskiness of that rule to be minimal. This discovery strongly suggests the rejection of the Efficient Market Hypothesis. Finally, additional models revealed that disequilibria exist in regional cattle markets. These were found to be related to forward contract deliveries, slaughter volumes, and distance between a market and the next closest.
Degree
Ph.D.
Advisors
Foster, Purdue University.
Subject Area
Agricultural economics
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