Coffee Supply and Demand

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Middle Eastern Finance and Economics ISSN: 1450-2889 Issue 8 (2010) © EuroJournals Publishing, Inc. 2010

An Analysis of Factors Affecting the Price and Volatility of Coffee Future Returns Anastasios Alexandridis Associate Professor in the Department of Business Administration Technological Education Institute (TEI) of West Macedonia Kila 50100 Kozani, Greece E-mail: Tel: +00306944523644; Fax: + 30 2461 39582 Abstract This paper examines the effect of financial and currency factors on the coffee future prices. The empirical results indicate that the stock market, and particularly the SP500, exerts positive impact on the coffee market. The findings also suggest that the energy markets influence positively the coffee market, whereas the bond market volatility affects it negatively. In addition, the structural analysis of coffee prices volatility showed that the conditional variance appears to be more volatile in response to positive shocks than to negative, contrary to the equities market. It also shows that the appreciation of U.S. dollar has a stabilizing effect on the conditional variance of the coffee return series. Keywords: Coffee futures; Crude oil; Ethanol; Bond; Exchange rates JEL Classification Codes: F39, G10, G15

1. Introduction
Coffee, a widely consumed beverage prepared from roasted seeds, is mainly cultivated in Latin America, Southeast Asia, and Africa. Although there are several different coffee species, two main species are farmed today, the Arabica and the Canephora, known also as Robusta coffee. Arabica coffee is most popular than Robusta accounting for 75-80% of the world's coffee production. The key players in the global coffee market include Brazil, Vietnam, Colombia and Indonesia. Coffee futures contracts are traded in the New York Mercantile Exchange, with contract deliveries occurring every year in March, May, July, September, and December. Despite a disagreement of the researchers regarding the kind of influence that the market of derivatives has on the underlying market, most of them agree that it is beneficial even if the volatility is increased or decreased because the derivatives’ market acts as a catalyst for the dissemination of information. Particularly, Danthine (1978) concluded that the derivatives’ market increases the depth of a market and consequently reduces its volatility. Stroll and Whaley (1988) in a similar manner claimed that the derivatives enforce the efficiency of a market. According to Schwartz and Laatsch (1991), futures increase the depth and the informative power of a market. Figlewski (1981) gave an elegant explanation for that: the derivatives’ market provides a mechanism for traders of insurance to hedge themselves against undesirable price changes. It distributes risk to a lot of investors and is finally being transferred through hedging spot positions to professional speculators who are capable, and probably willing, of taking it. Consequently, this transfer may reduce the need to embody risk premium in spot

Middle Eastern Finance and Economics - Issue 8 (2010)


market transactions to compensate for the risk variations resulting to a significant improvement of the spot market operation. Moreover, according to Lee and Oak (1992a), well informed speculators mainly buy at low prices, pushing prices up and sell at high prices, thus forcing prices to fall, a fact that stabilizes the market and consequently reduces volatility. The creation of new channels of information and their rapid evaluation and dissemination is another factor which enhances the efficiency of the underlying spot market. Consequently, the market may become more efficient considering that derivatives expand investment opportunities, facilitate hedging and improve daily operation and thus render the market substantially more mature and less uncertain. However, coffee future prices have been quite volatile in the last decade....
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