TESTING INTERNATIONAL PRICE TRANSMISSION UNDER ...

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Empirical Tests for Spatial Price Analysis mechanisms used to develop empirical tests, though the interpretation of the results is different 17 . The basic model is the following: P ε t = β + β P t + β Tt + (3.1) 1 0 1 2 2 t where Pt are the prices in locations 1 and 2 at time t, T represents transaction costs and ε is the error term. Arbitrage conditions are assumed to hold instantaneously (as no lags are included in the model). Markets are taken to be perfectly integrated if β = β = 1 1 2 (3.2) and 0 0 = β (3.3) These models can be evaluated both in levels or in logarithmic form. In the first case, the coefficient of the price term represents the marginal effect of the change of one price to the other; in the second one, this coefficient represents the price transmission elasticity. In both cases, a value of 1 is assumed for perfectly integrated markets 18 . In most of the revised literature price transmission equations are normally written in logarithmic form, i.e. t = β + β p t + β tt + (3.4) 1 0 1 2 2 t p ε the underlying equation in levels being 0 β1 P1 t e P2 t Tt = β β2 e ε t where p = log P and t = log T. β1 is the elasticity of price transmission. (3.5) 17 Given two prices, P1 and P 2, the correlation coefficient is given by ρ 12 = σ 12/(σ 1σ 2), where σ 12 is the covariance between the two prices and σ i is the standard deviation of price i. In a regression written in the general form P 1= α +β P 2, the least square estimate of β is σ 12/σ 22, where σ 22 is the variance of P 2. Since β = ρ 12(σ 1/σ 2), β and ρ 12 are proportional and of the same sign. 18 Sharma (2002) notes that, despite the complete pass-through of prices in absolute terms (what he calls “absolute price transmission”), the price transmission in proportional terms (or “proportional” price transmission, i.e. the percentage change in domestic -1- price divided by percentage change in world -2- price) is smaller than one in the import case and higher than one in the export case. This effect is larger the bigger the constant term; only if the constant is zero, the absolute and the proportional price transmission will be equal. In this work, following Fackler and Goodwin (2001), when talking about price elasticities we will refer to absolute price transmission. 25
Empirical Tests for Spatial Price Analysis Usually, it is assumed that β2 = 0 and the assumption that β0 = 0 is, in turn, relaxed, so that this term becomes a crude mean to represent transaction costs (or, generally, all other factors contributing to price differentials which are not included amongst the regressors; see paragraph 2.3, and, for an example, Thompson et al. 2002a, p.1043). In this way, the strong assumption which is implicitly made in all linear regression models is that all factors possibly contributing to price differentials but not taken into account in the model are fixed (if a linear specification is used; or a constant proportion of prices, when variables are expressed in logarithms 19 ). Moreover, in linear regression models, it is clear that either one of the two prices must be assumed to be exogenous (Richardson 1978), or otherwise simultaneity problems can be addressed with Instrumental Variables techniques (Goodwin et al. 1990). Numerous different versions of the regression model can be developed. For example, Stigler and Sherwin (1985) use simple price correlation analysis amongst prices to establish their belonging to the same market. In Richardson (1978), log differenced prices are employed in a linear regression model. If the role of the exchange rate, e (defined as the ratio of the domestic -country 1- versus foreign -country 2- currency) is made explicit in the logarithmic form of the LOP, we have: 26 p ε t = β + β p t + β tt + β et + (3.6) 1 0 1 2 2 3 t where e is expected to have a positive sign 20 . The underlying assumption is that the level of disaggregation allows the exchange rate to be taken as exogenous. Anyway, most commonly, commodity prices are directly expressed in the same currency 21 . A first shortcoming of this approach, that, as we will see, is common to all models relying on price information only, is that unknown common components could explain price co-movement regardless of the extent to which markets are linked. Moreover, in theory, any value of the correlation coefficient is consistent with integrated markets, depending on the size of transaction costs. A final, fundamental flaw is that what is here tested is the strong form of the LOP, and not the validity of the arbitrage condition (which, differently from the first, would also 19 This hypothesis would seem to be quite reliable for the data used in this analysis; see figure 4.11. 20 Equation (3.6) can be interpreted as an export pricing equation for the home country: a lower e (appreciation of the home country currency) reduces foreign sales unless the exporter lowers its price (p 1 decreases). Alternatively, viewing it as an import pricing equation for the home country, a higher e (depreciation of the home country) makes imports more expensive, allowing domestic producers to raise their prices (p 1 increases) (Vollrath and Hallahan 2006, p.61). 21 When not, results are generally not altered (Thompson 1999; Bukenya and Labys 2005).
Page 1 and 2: TESTING INTERNATIONAL PRICE TRANSMI
Page 3 and 4: Associazione “Alessandro Bartola
Page 6 and 7: Index 1 INTRODUCTION ..............
Page 8 and 9: 1 INTRODUCTION The notion of “pri
Page 10 and 11: Introduction These recent phenomena
Page 12: Introduction Whereas the Common Agr
Page 15 and 16: Price Transmission and the Law of O
Page 24 and 25: 3 EMPIRICAL TESTS FOR SPATIAL PRICE
Page 28 and 29: Empirical Tests for Spatial Price A
Page 32 and 33: = β 2 i0 Empirical Tests for Spati
Page 48 and 49: ∆p + t ∑ ⎡β⎤ ' ⎡ p t =
Page 54 and 55: 4 INTERNATIONAL SOFT WHEAT MARKETS
Page 56 and 57: International Soft Wheat Markets Un
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5 EMPIRICAL ANALYSIS: COINTEGRATION
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Empirical Analysis: Cointegration M
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α LM test ARCH(13) Empirical Analy
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6 EMPIRICAL ANALYSIS: COINTEGRATION
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Concluding Remarks These models rep
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REFERENCES Alderman, H., 1992. Inte
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References agricultural policies: s
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References Isard, P., 1977. How far
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References Thompson, S. R., Sul, D.
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Annexes 124 Annex A - Empirical ana
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Annexes METHODOLOGY DATA USED MAJOR
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Annexes Variable swfr 138 Annex B -
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Annexes Variable swfr 140 Table B.3
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Annexes 142 Table B.7 - Unit root t
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Annexes 144 Table C.5 - Cointegrati
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Annexes 146 Table D.4 - Unit root t
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Annexes 148 Annex E - Unit root tes
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Annexes Table E.5 - Unit root tests
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The notion of “price transmission
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