Price efficiency and speculative trading in cocoa futures markets

In recent years a number of market participants called into question the efficiency of the price discoverymechanism in commodity futures markets. They believe that speculators move commodity futures marketsaway from their fundamentals by distorting prices and exacerbating volatility. The smoking gun of theseallegations is the empirical observation that speculative buying (selling) precedes movements in the cocoafutures markets. Among soft commodities, the cocoa futures market represents an interesting case study. Inthe last decades, speculators’ open interest is increased by nearly 4 times, fuelling the apprehension ofpractitioners and market analysts. This paper evaluates the efficiency of the price discovery mechanism incocoa futures markets. Results show that the price discovery mechanism in both LIFFE and NYBOT cocoafutures markets is efficient. In addition, they rule out the existence of any casual relationship betweenspeculative activity and cocoa prices (i.e. level and volatility) at the least for the NYBOT. This evidencesupports the hypothesis that successful speculators are reacting quicker than any other market participant tonew information emerging from the market. That is why profitable speculative buying (selling) occurs justbefore the market makes a move.