TESTING INTERNATIONAL PRICE TRANSMISSION UNDER ...

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1 INTRODUCTION The notion of “price transmission” refers to the co-movement shown by prices of the same good in different locations. In the early literature already, spatial price analysis was devoted to defining markets (Fackler and Goodwin 2001, p.973): an economic market is the spatial area “within which the price of a good tends toward uniformity, allowance being made for transportation costs” (Stigler 1966 cited Fackler and Goodwin 2001, p.974). When spatially separated markets are considered, price transmission analyses play a crucial role in trying to assess how efficiently integrated they are, i.e. to which extent rational arbitrage operates. Most works essentially aim at verifying whether the Law of One Price (LOP) holds between different markets; this Law simply states that homogeneous goods in spatially separated locations will have a unique price, when expressed in the same currency, net of transport costs. International price transmission is an issue which has received considerable attention, and different econometric techniques have been used in this respect. In particular, cointegration models have shown to have an “intuitive appeal”, as they consent to disentangle short and long run dynamics. Prices are assumed to be linked in the long run despite being allowed to diverge from each other in the short term. Nonetheless, despite the use of increasingly sophisticated techniques, evidence supporting the LOP is weak, and empirical findings are extremely mixed. This is not surprising, given that there is wide acknowledgment that the hypothesis of the LOP are quite unlikely to hold in practice: the LOP is simply expected to regulate spatial price relations in a “frictionless undistorted world” (Conforti 2004, p.1), while, in fact, a number of factors are expected to prevent prices from convergence. This work, in particular, will focus on how domestic and border policies affect international price transmission. In this respect, (often) highly policy-regulated agricultural commodities markets are extremely interesting for the analysis. Indeed, traditionally, agricultural commodities’ markets, especially in developed countries, have been
Introduction characterized by a high degree of policy intervention, whose motivations deeply hinge on some inherent characters of agricultural production. First of all, agriculture produces food, which is of strategic importance. Moreover, the agricultural production is characterized by a high degree of uncertainty, being dependant on natural production factors. Secondly, agricultural enterprises are small if compared to the size of the market, and their structural adjustment process is normally slow and constrained by the rigid supply of some of the production factors. Thirdly, agricultural markets are often characterized by a high degree of competition, and both market demand and supply are typically inelastic, rendering both producers’ yields and consumers’ expenditures extremely volatile (Hallett 1968). In addition to these, and principally in developed countries, other reasons have been added to justify the presence of policy subsidies, concerning the specific functions agriculture performs in the rural environment (the so called “multifunctional” character of agriculture 1 ). However, in the past months, it has been the dramatic increase that commodities prices have experienced on international markets that drew the attention of both the media and of economic analysts on the agricultural sector. The rise in food commodity prices is due to a number of factors. The increasing demand of the emerging economies, especially for livestock products, the rising biofuels demand, and, on the supply side, the steady increase in energy prices can be classified as structural factors, whereas, as short term factors, we can mention the adverse meteorological conditions occurring during last year. The sudden increase in agricultural prices, together with the high levels of volatility they experienced, brought, if possible, an even more renewed interest in the policy debate about the reform agricultural policies should undergo to tackle an evolving global context, in which supply and demand forces are characterized by major interdependences. In this context, the analysis of how prices are transmitted, and of how intervention policies are likely to affect such mechanisms, is crucial. Understanding how price shocks are transmitted between different countries, and how such transmission has been affected, in the past, by policy regimes, is a prerequisite for policy analysis and future intervention. For the European Union (EU), this basically means analyzing to which extent, provided the presence of its regulatory framework, the world price has affected and has interacted with the domestic one. 1 “Beyond its primary function of supplying food and fibre, agricultural activity can also shape the landscape, provide environmental benefits such as land conservation, the sustainable management of renewable natural resources and the preservation of biodiversity, and contribute to the socio-economic viability of many rural areas” (OECD 2001). 8
Page 1 and 2: TESTING INTERNATIONAL PRICE TRANSMI
Page 3 and 4: Associazione “Alessandro Bartola
Page 6 and 7: Index 1 INTRODUCTION ..............
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 26 and 27: Empirical Tests for Spatial Price A
Page 32 and 33: = β 2 i0 Empirical Tests for Spati
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Page 54 and 55: 4 INTERNATIONAL SOFT WHEAT MARKETS
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30.000 20.000 10.000 0 1961 1963 19
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International Soft Wheat Markets Un
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250 200 150 100 50 1978:12 Internat
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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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