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Senior Advisor

Non-Convergence in Domestic Commodity Futures Markets: Causes, Consequences and Remedies

"What Is the Issue?
From 2005 to 2010, many corn, soybean, and wheat futures contracts repeatedly expired at prices
much higher than corresponding delivery market cash prices. In principle, these futures contracts
can be exchanged for the physical commodity at expiration, so their prices should converge with
the price of the underlying cash commodity. This sustained period of non-convergence, as well as
its magnitude, was unprecedented in domestic commodity markets. This was a cause of concern
for many market participants, policymakers, and economists, who worried that those convergence
failures signaled a weakening of the traditional price discovery and risk management roles of
these futures markets, and ultimately, a less effi cient allocation of agricultural resources.
What Did the Study Find?
Market observers offered several explanations for the non-convergence puzzle, but none was
tested rigorously and shown to explain the problem. One theory is that “excessive speculation” by
nontraditional fi nancial fi rms, like Commodity Index Traders (CITs), overpowered the ability of
arbitrageurs to balance derivative and cash prices, leading to non-convergence in wheat markets.
While it is true that CIT trading increased substantially during the time when non-convergence
became a problem, this theory suffers from several theoretical limitations. For example, if
purchasing behavior by these fi rms drove up the derivative price relative to the cash price, their
equally sizable selling behavior before contract expiration should serve to force those prices
together, leading to convergence. To maintain portfolio exposure, CITs enter one contract and
then roll to the next, buying at fi rst and holding it until it almost expires, then selling it to buy the
next expiration.
In another account, production and trade patterns for these commodities shifted away from longestablished
delivery markets, limiting the ability of fi rms to arbitrage away the price difference
between the two markets by engaging in the delivery process. On the other hand, the commercial
fl ow for wheat in particular has bypassed these delivery markets for decades, so this theory does
not adequately explain convergence problems observed since 2005.
United States Department of Agriculture
A report summary from the Economic Research Service August 2013
ERS is a primary source
of economic research and
analysis from the U.S.
Department of Agriculture,
providing timely information
on economic and policy
issues related to agriculture,
food, the environment,and
rural America.
Find the full report at
Michael K. Adjemian, Philip Garcia, Scott Irwin,
and Aaron Smith
Non-Convergence in Domestic
Commodity Futures Markets: Causes,
Consequences, and Remedies
We conclude that recent convergence failures in grain markets are attributable to inconsistent storage rates for
the physical commodity and its derivative, a delivery instrument. Specifi cally, the exchange-set storage rate of
the delivery instrument was too low relative to the true price of storage. The resulting wedge between the costs
of holding delivery instruments and storing physical grain led to an expansion of the delivery month basis,
preventing convergence even in a competitive market. The available empirical evidence fi ts this storage rate argument:
inventories, which drive the wedge, are the most important factor in explaining the change in the expiring
basis. In contrast, no empirical support was found for the CIT theory: trading activities by these fi rms are not
found to affect the change in the basis over time, at any acceptable level of statistical signifi cance.
How Was the Study Conducted?
This report summarizes the basic theory of how the storage-rate problem caused expiring futures to diverge from
cash prices and shows how the wedge explains the large magnitudes of recent non-convergence. We also discuss
prominent alternative explanations for non-convergence and show why they are not supported theoretically or
empirically. Based on these fi ndings, we discuss the likely impact of various proposed policy options on the prospect
of achieving convergence in grain and soybean markets.


by Michael Adjemian, Philip Garcia, Scott Irwin, and Aaron Smith

Economic Information Bulletin No. (EIB-115) 33 pp, August 2013

From 2005-10, the price of expiring U.S. corn, soybean, and wheat futures contracts settled much higher than corresponding delivery market cash prices. Theories about why this unprecedented non-convergence occurred are examined along with policy options to prevent it in the future.

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