Strictly Speaking, the Law of One Price Works in Commodity Markets

Pippenger and Phillips (forthcoming) show how four common pitfalls cause cointegration tests to reject the law of one price when in fact it holds. They conclude that there is no reliable evidence that rejects the LOP. We consider a stronger test, half lives. The literature suggests that half lives for differentials in spot prices last several quarters. We show that, when we avoid the four common pitfalls, half lives for differentials for spot grain prices range from 3 to 8 weeks. Such short half lives have potentially important implications for the Borders literature and real exchange rates.