Analysis of open-outcry trading using Bayesian models

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In futures markets, price determination for many agricultural commodities occurs in an exchange's open outcry pit. Sellers shout out offers for a given futures contract and buyers shout out bids until a price is agreed and a transaction occurs. The difference between bid and ask prices represents the cost of liquidity. Understanding the behaviour of the cost of liquidity is important for market participants because it represents the cost of trading and it is usually viewed as an indicator of market quality. However, the bid and ask prices are not recorded, which complicates the estimation of the cost of liquidity as standard econometric techniques cannot be used. In addition to this limitation, changes observed in agricultural prices in the past few years have generated interest in identifying new market relationships. The high degree of fluctuation of prices has rekindled questions regarding the influence of volatile oil, exchange rate markets, and increased participation of financial investors on agricultural markets. The objective of this research program is to develop a method appropriate to model the cost of liquidity when standard econometric techniques cannot be used and for the new market environment where new relationships have emerged. Estimating the effect of these variables is important for decision makers seeking to implement cost-reducing marketing strategies and to manage their liquidity risk. Knowing the costs of operating in the futures market is particularly important for the Canadian livestock market, which has weakened over the past few years due to the outbreak of the mad-cow disease in 2003, followed by a higher U.S./Canadian dollar exchange rate variability, commodity prices-exchange rate interaction effects, and U.S. monetary shocks. While low prices and U.S. border policies cannot be controlled, there may be strategies that can be implemented to reduce the risks associated with price fluctuations. This research agenda thus seeks to assess some of these strategies to better prepare Canadian agricultural markets for the future.