Spreads and Non‐Convergence in Chicago Board of Trade Corn, Soybean, and Wheat Futures: Are Index Funds to Blame?

Abstract

This paper evaluates the role that index funds have played in recent convergence problems of Chicago Board of Trade corn, soybean, and wheat futures contracts. These new market participants are widely considered to have inflated futures prices and/or expanded spreads between futures prices. Large spreads in futures markets contribute to a lack of convergence by uncoupling cash and futures markets. Statistical tests provide no evidence that rolling of positions by index funds or the initiation of large index positions in a “crowded market space” have contributed to an expansion of the spreads.

Optimal Dynamic Basis Trading

“…This non-convergence phenomenon was commonly observed in the grains markets. As reported in Irwin et al (2011), Adjemian et al (2013), and Garcia et al (2015, for most of 2005-2010 futures contracts expired up to 35% above the spot price. As a result, some cash-and-carry traders may choose to close their positions prior to maturity to limit risk exposure.…”

“…This non-convergence phenomenon was commonly observed in the grains markets. As reported in Irwin et al (2011), Adjemian et al (2013), and Garcia et al (2015, for most of 2005-2010 futures contracts expired up to 35% above the spot price. As a result, some cash-and-carry traders may choose to close their positions prior to maturity to limit risk exposure.Early works on pricing of futures contracts, such as Cox et al (1981) and Modest and Sundaresan (1983), established no-arbitrage relationships between the spot price and associated futures prices.…”

Understanding the non-convergence of agricultural futures via stochastic storage costs and timing options

“…The speculator hypothesis for non-convergence postulates that large long positions held by commodity index traders (CITs) have made it impossible for arbitrageurs to carry sufficient grain forward to drive terminal prices to convergence (see Tang and Xiong (2012) an example of the effects of excess speculation). While the speculator hypothesis is plausible, empirical studies by Garcia et al (2014) and Irwin et al (2011) found no evidence that rolling or initiation of large positions by index funds had contributed to an expansion of the basis. In this paper, we illustrate mathematically how the non-convergence phenomenon can arise under rational no-arbitrage models with stochastic storage rates.…”

How financial investment distorts food prices: evidence from U.S. grain markets

“…The literature, which investigates these episodes of convergence failure, pinpoints the anomaly as a misalignment between the exchange storage premium and commercial storage rates, paired with a change in delivery instruments (Aulerich et al., ; Garcia et al., ; Irwin et al., ). These factors are thought to have jointly contributed to limits to arbitrage and, hence, facilitated nonconvergence.…”

“…These factors are thought to have jointly contributed to limits to arbitrage and, hence, facilitated nonconvergence. Although the potential link between financial investment and convergence failure was considered (U.S. Senate, ), it has not yet been incorporated formally, and only two studies have empirically tested the hypothesized link (Garcia et al., ; Irwin et al., ).…”