Transportation and Quality Adjusted Basis: Does the Law of One Price Hold for Feeder Cattle?

Beef cattle and calves are raised in all areas of the United States. Since beef cattle are scattered throughout the US, there are many different types of cattle with numerous different quality characteristics which are valued differently. Many calves raised until weaning age across the US are then sent to cattle feeding areas primarily located in Texas, Kansas, Colorado, and Nebraska. The prices that are offered for beef calves vary considerably based on quality and location. The theory of the law of one price suggests that prices in areas that trade should not differ by more than the cost of transportation. Implicit in the law of one price is that the product is homogenous in nature which is not the case with beef cattle. To test the law of one price, prices in the feeder cattle markets that trade should be equal after those prices have been adjusted for the cost of transportation and for differences in quality. Consequently, the objective of this thesis is to adjust prices for transportation costs and quality characteristics to determine if the law of one price holds in the US feeder cattle market. Data for this dissertation were obtained from Superior Livestock Auction in Brush, Colorado. The original data set included over 30,000 cattle lots sold throughout the entire US from 2004-2006 which includes valuable information such as price, breed, sex, number of head, days to delivery, location of sale, and destination of sale for each cattle lot. However, the data were narrowed to examine price and quality for weaned steer and heifer calves in the fall. This narrowed data set still contained 9,570 cattle lots which includes, specifically, steer and heifer calves, weighing between 450-700 pounds, and delivered in October and November. In order to determine if the law of one price holds for feeder cattle, first, a Hedonic regression analysis was used to determine the value of selected cattle, lot, and market characteristics. Second, the cost of transportation was calculated by figuring freight rates and animal shrinkage. Prices were then adjusted for freight rates and shrinkage values and for quality differences to determine if prices were equivalent across regions of the US and across states within a specific region of the US. Results from the Hedonic model showed that most cattle characteristics yielded expected results, and that there are differences in quality characteristics in cattle which affect the price. Further results revealed that the transportation adjusted prices varied by more than transportation costs, and that when adjusted for transportation costs, price were not the same across regions of the country. In combining quality characteristics and transportation costs, results also revealed that prices were different by region and by states within a region. Thus, based on the results from the data, it does not appear that the law of one price is upheld in the US feeder cattle market. The implications of the results are that there may be opportunities for arbitrage in feeder cattle markets. The results also indicate that cattle producers who are more distant from major cattle feeding areas receive prices for their calves that are higher than would be justified based on transportation costs and that producers who are closer to major cattle feeding areas receive prices for their calves that are less than should be expected based on transportation costs