CHICAGO — Switching from an open-outcry system of trading
futures and options contracts to electronic trading at the Chicago Board of
Trade has significantly impacted the marketplace.
“The last 10 years has seen the most structural change in
agricultural and commodity futures markets that we saw in the previous 150
years,” said Scott Irwin, professor in the Department of Agricultural and
Consumer Economics at the University of Illinois.
“The switch to electronic trading is a once-a-century
evolution for a market mechanism,” added Irwin during the Taming Agricultural
Risks meeting hosted by the Federal Reserve Bank of Chicago.
“All but about half of options trading is now on Globex,” he
reported. “It’s only a matter of time and technology before all futures and
options transactions will be on Globex-style platforms.”
The electronic trading has changed the nature of orders and
the trade frequency, and new kinds of traders have risen.
“The high-frequency trader or automated trader can make
hundreds, thousands and even millions of trades a day, which is only possible in
an electronic market,” Irwin said.
The second structural change has been the revolution in
“With online discount brokers, it is easy today to get
online, give a credit card and start trading,” Irwin said. “And with a smart
phone, you don’t even have to be at your desktop to trade.”
Another structural change is the rise of the passive
“These are mutual funds that track the price movements of a
basket or portfolio of commodities,” the professor said.
“With all of these changes, by the decade-ending 2010 there
has been a tripling to quadrupling of the trading volume in the agricultural
futures markets,” he said. “This is an impressive list of changes in a short
amount of time.”
These rapid changes in the marketplace resulted in some
people being concerned that the influence of the passive investor has resulted
in prices spikes of commodities, especially the wheat market, that have exceeded
the fundamental value.
“This heated debate launched a flurry of academic studies
that I got involved in,” Irwin said.
He showed a chart that included both the open interest in
the CBOT Chicago wheat contract starting in January 2004 and the nearby CBOT
wheat futures contract.
“The rapid growth in the index positions preceded the run-up
in wheat prices by almost two years,” he noted. “And while the wheat prices were
rapidly running up in 2007-’08, the investors’ position was on a slow
The professor has completed a number of studies on this
topic, and the results of studies all say the same thing.
“I share concerns with organizations about access and price
of food particularly in poor countries,” Irwin said. “But they have aimed their
concern at the wrong target.”
A bubble in the market is a gigantic spike in price followed
by a huge collapse.
“The question is how to determine the difference between a
bubble and a non-bubble aspect,” the professor said.
Irwin recently completed a study with a graduate student at
the U of I, which looked at the nearby futures price from 2004 to 2012 of four
major grain markets — corn, soybeans, Chicago wheat and Kansas City wheat.
“For corn, there were eight episodes in total that the test
said some kind of bubble was occurring,” he said.
“One bubble around May and June of 2008 lasted about six
days,” he noted. “And there were no bubbles after June 2008. Prices went very
high in 2010, 2011 and 2012, and there is not a single piece of evidence that
prices were bubbling.”
This technique only indicates when a bubble is occurring,
“Then you have to do further tests to see how big it was,”
“The story is basically the same for soybeans,” he
And for wheat, concerns have been expressed about the high
prices during the spring and summer of 2008.
“During the entire length of the 2007-’08 spike in wheat
prices, there was not a single day picked up by this sophisticated test that
exhibited bubble-type behavior,” Irwin said.
“This evidence, to me, is more important than all the other
studies I’ve done trying to correlate index positions to prices,” he said.
“The markets aren’t perfect, and on occasion, for very short
periods of time, they may go up a little bit too rapidly,” Irwin added. “But
there is nothing that would suggest a need for dramatic new regulations for
these very brief periods.”
“We have learned that the index investment did not drive
agricultural price spikes, the agricultural futures markets were not excessively
speculative and the price bubbles in agricultural futures markets were
infrequent, small and short-lived,” he said.