Bid-Ask Spreads, Volume, and Volatility: Evidence from Livestock Markets

Understanding the determinants of liquidity costs in agricultural futures markets is hampered by a need to use proxies for the bid-ask spread which are often biased, and by a failure to account for a jointly determined micro-market structure. We estimate liquidity costs and its determinants for the live cattle and hog futures markets using alternative liquidity cost estimators, intraday prices and micro-market information. Volume and volatility are simultaneously determined and significantly related to the bid-ask spread. Daily volume is negatively related to the spread while volatility and volume per transaction display positive relationships. Electronic trading has a significant competitive effect on liquidity costs, particularly in the live cattle market. Results are sensitive to the bid-ask spread measure, with a modified Bayesian method providing estimates most consistent with expectations and the competitive structure found in these markets.Bayesian estimation, bid-ask spread determinants, liquidity cost, Livestock Production/Industries, Marketing,

Market Depth in Lean Hog and Live Cattle Futures Markets

Liquidity costs in futures markets are not observed directly because bids and offers occur in an open outcry pit and are not recorded. Traditional estimation of these costs has focused on bidask spreads using transaction prices. However, the bid-ask spread only captures the tightness of the market price. As the volume increases measures of market depth which identify how the order flow moves prices become important information. We estimate market depth for lean hogs and live cattle markets using a Bayesian MCMC method to estimate unobserved data. While the markets are highly liquid, our results show that cost- and risk-reducing strategies may exist. Liquidity costs are highest when larger volumes are traded at distant contracts. For hogs the market becomes less liquid prior to the expiration month. For cattle this occurs during the expiration month when the liquidity risk is also higher. For both markets this coincides with periods of low volume. For the nearby contract highest trading volume occurs at the beginning of the month prior to expiration and lowest trading volume occurs in the expiration month. For both commodities the cumulative effect of volume on price change may lead to liquidity costs higher than a tick.Bayesian MCMC, lean hog futures, liquidity cost, live cattle futures, market depth, market microstructure, Agricultural Finance,

Estimating Liquidity Costs in Agricultural Futures Markets using Bayesian Methods

Estimation of liquidity costs in futures markets is challenging because bid-ask spreads are usually not observed. Several estimators of liquidity costs exist that use transaction data, but there is little agreement on their relative accuracy and usefulness, and their performance has been questioned. We use a Bayesian method proposed by Hasbrouck which possesses conceptually desirable properties to estimate liquidity costs of six agricultural future contracts. The method builds on Roll's model and uses Markov Chain Monte Carlo estimation. Our Bayesian estimates are lower than more traditional estimates and as anticipated decrease even more when more realistic assumptions such as discreteness are incorporated. The findings demonstrate the need for further research to clarify the usefulness and accuracy of the procedure.Marketing,

To What Surprises Do Hog Futures Markets Respond?

We re-assess the effect of new information contained in the Hogs and Pigs Reports (HPR) focusing on the rationality of the announcements. We find that HPR preliminary numbers are irrational estimates of the final numbers and market expectations before the announcements are also irrational estimates of HPR numbers. Based on these results we modify the conventional measure of new information entering into the market (i.e., announcement - market expectation), and incorporate final estimates and the market’s best forecast into the analysis. Results show modest statistical differences between the conventional and modified measures of surprise; however some economic differences, as large as 27 cents/cwt, emerged. We also find that, as expected, marketings information has a larger effect on short-term price changes and breedings information has a larger effect on long-term price changes.USDA announcements, HPR, rationality, new information, two-limit tobit,

To What Surprises Do Hog Futures Markets Respond?

We reassess the effect of new information in the Hogs and Pigs Reports (HPR) focusing on announcements’ rationality and alternative surprises. HPR announcements are irrational estimates of final estimates, and market expectations are irrational estimates of HPR numbers. Using the market’s best forecast and incorporating final estimates, we modify conventional information measures. Despite differences as large as 33 cents/cwt in price response, findings suggest there is little to differentiate among surprise measures. Regardless, the message that HPR provides new information to the market is strongly supported. On balance, marketing (breeding) information has a larger effect on short-term (long-term) price changes.HPR, new information, rationality, two-limit tobit, USDA announcements, Agribusiness, Agricultural Finance, C24, Q13,

Impact of Free Trade Agreements on the Colombian Beef Sector

Colombia negotiated bilateral Trade Agreements (TAs) with the United States and with the MERCOSUR region (Argentina, Brazil, Paraguay, and Uruguay). Colombian cattle and beef interest groups argue that TAs hurt the local beef supply chain. We employ a partial equilibrium framework to assess the impact of these TAs on the welfare of cattle producers, beef marketers and meat consumers in Colombia. Our results suggest that with free imports of chicken parts from the U.S, beef consumption and retail prices of beef both decrease and the derived demand and prices of fed cattle decrease. With beef imports from the MERCOSUR region, domestic beef prices and beef production fall, but total beef consumption increases. Overall, consumers are better off and there are net gains to society with free trade agreements. These net gains tend to increase over time, as Colombia gradually decreases the tariff for imported beef. We identify the reduction in marginal costs required to compete with imported beef, primarily from MERCOSUR. We argue that this is possible because the elimination of trade barriers is gradual and the Colombian beef supply chain can compete with imported meats with an annual reduction of marginal costs between 2 and 4%.Beef, Colombia, partial equilibrium, trade liberalization, International Relations/Trade, F14, D60, Q17,

Cash Settlement of Lean Hog Futures Contracts Reexamined

In 1997 the Chicago Mercantile Exchange replaced its live hog futures contract with a cash settlement mechanism based on a Lean Hog Index. Although cash settlement was expected to increase the use of the contract as a hedging tool, producers and packers are concerned that convergence between cash and futures prices is not occurring and that the volatility of the lean hog contract basis has increased in recent years. The purpose of the paper is to reexamine cash settlement of lean hog futures contracts as a hedging tool, focusing on basis behavior and management of basis risk. We also investigate alternative hedging instruments that take into account location differences between regional cash prices and the CME lean hog index. Our results indicate that basis has widened and its variability prior to expiration has increased in the cash settlement period. Nevertheless, there is no evidence that ex-ante basis risk has increased, suggesting that the ability to forecast basis prior to expiration has not decreased with cash settlement. Our findings indicate that a contract on a regional basis can reduce producer price risk and may increase market returns. The benefits of a regional basis appear to accrue from providing the producer with an opportunity to manage the variability in returns associated with both the price level and basis.basis behavior, cash settlement, ex-ante basis risk, lean hogs futures contract, regional basis, Agricultural Finance,

Complex Choices: Producers Risk Management Strategies

Producers have a wide variety of risk management instruments available. How do producers make a choice of risk management instruments? Using the recently developed choice bracketing framework, we examine what risk management strategies producers use and identify the factors that drive their risk management decisions. Our results identify that producers use a wide variety of combinations of risk management instruments and that they bracket their choices into sets of alternative risk management instruments. Using multinomial logit models to estimate the choice process provides information about the factors that influence producers' decision making. The results show that broad bracketing producers use different risk management instruments than narrow bracketers. Policy makers and financial institutions can improve the performance of their programs and products when they are able to identify the bracketing level of segments of producers.Risk and Uncertainty,