Futures Market Failure

In a well-functioning futures market, the futures price on the expiration date equals the price of the underlying asset on that date. An unprecedented episode of non-convergence in Chicago Board of Trade (CBOT) corn, soybeans, and wheat began in late 2005, and with the exception of some brief periods, largely persisted through 2010. Most recently, the Kansas City Board of Trade (KCBOT) wheat contract also has demonstrated convergence problems. During this unprecedented and extended episode of non-convergence, futures contracts have expired at prices up to 35 percent greater than the prevailing cash grain price. Using a rational expectations commodity storage model, we show how such non-convergence can be produced by the institutional structure of the delivery market. Specifically, we show how a wedge between the marginal cost of storing the physical commodity and the cost of carrying the delivery instrument causes non-convergence. We fit the model to corn, soybeans, and wheat and find strong support for our model