An Empirical Anecdote of Price Discovery in Indian Spot and Future Commodity Markets

Risk management is very critical for the organization to survive and compete in the present day business environment. From the last two decades derivatives are popular as less costly and efficient risk management tools. The increased use of derivatives as risk management vehicle is basically due to their ability to predict future cash flows. Future cash flows can be predicted more accurately in derivatives if we understand the process of price discovery. Price discovery is the process of incorporating information produced and transmitted across spot and future markets in the commodity price. Both spot and future commodity markets react to the similar information but which market first react first is important for us because this market acts as market leader in price discovery. This piece of research tries to analyses the price discovery behavior of four indices i.e. mcx Comdex, mcx metal, mcx agri and mcx energy for the period 1st January 2006 to 31st December 2012. The data is first verified for stationarity by using Augmented Dickey Fuller Test (ADF) and Phillips-Perron (PP). ADF & PP Test unveiled that the data has unit root which means the data is not stationary. The data is converted into stationary time series by taking their first difference. Johansen Co-integration Test reveals a long run co-integration between the spot and future prices of all indices taken for the study. To test the short run Cointegration VECGranger Causality method was used which predict a short run bi-directional relationship between the spot and future prices of all commodities. No lead lag relationship has been found between the spot and future prices of all the indices taken for study.