The effect of futures markets and corners on storage and spot price variability

When a futures market is introduced, the volume of storage should become more sensitive to changes in the return to storage. The increase in storage sensitivity means that storage will absorba larger proportion of demand and supply shocks than it did previously, reducing spot price volatility. Data from the Chicago Board of Trade support he hypotheses of increased storage sensitivity and reduced spot price volatility. The effect of futures on spot price volatility is sensitive to the competitive structure of the futures market. Futures market manipulation causes pot price variance to increase. Despite manipulation, the development of the wheat futures market caused the coefficient of variation of spot price to decline significantly. Key words: corners, futures markets, price volatility. For many commodit ies, storage exists as a way to smooth consumpt ion and production. Storage bolsters demand in t imes of abundance and sup-p ly in t imes of scarc i ty, thus reduc ing cash price swings. Storage is r isky, however, s ince next per iod's price is unknown when inventory levels are chosen. When available, futures can be used to manage price risk. It is argued that futures encourage storage, e i ther by reducing the r isk storers face (Gi lbert) or by prov id ing agents with more information regarding the ac-tual return to storage (Gray, Wi l l iams, Work-ing). S ince futures markets reduce the r isk of storage, storage wil l become more sensit ive to changes in the return to storage. This increased sens i t iv i ty w i l l in turn dampen cash pr ice swings, leading to a less variable cash price. The present paper adds to the l i terature in several d imensions. First, the effect of a futures market on storage is est imated. Several theo