Commodity Markets Price Discover

23/08/2020 1 By indiafreenotes

The price discovery process (also called price discovery mechanism) is the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers. The futures and options market serve important functions of price discovery. The individuals with better information and judgement participate in these markets to take advantage of such information. When some new information arrives, perhaps some good news about the economy, for instance, the actions of speculators quickly feed their information into the derivatives market causing changes in price of derivatives. These markets are usually the first ones to react as the transaction cost is much lower in these markets than in the spot market. Therefore, these markets indicate what is likely to happen and thus assist in better price discovery.

The Forward/Future Market is not primarily responsible for price rise. The commodity futures market is a mechanism for price discovery and price risk management. The price of any commodity is determined by actual demand and supply position in the market. The futures market merely discovers the likely prices of a given commodity at future points of time depending on the expectations of supply and demand. .

.The intermediaries do not get large chunk of profit of farmers due to Forward/Future Market. The future prices are discovered in a transparent manner on the online platforms of the national commodity derivatives exchanges. The future market leads to reduction in seasonal price volatility which leads to better price realization for the farmer at the time of harvest. With the help of information on future price trends, and probable supply and demand of various commodities, the farmers can plan their cultivation as well as storage and sale of their produce in advance. .

The Forward Markets Commission has implemented a project to disseminate the future prices and spot prices by installing Ticker Boards at important Mandis/Agricultural Produce Market Committees etc. Prices are also being disseminated through SMS alerts and local newspapers. This has helped to reduce the information asymmetry and enables the farmer in realizing a better price for his produce from the intermediaries in commodity spot markets.

Factors of sensitivity

Recent changes in market regulations, since the collapse of Lehman Brothers, have outlined practices that affect the price discovery mechanism.[citation needed] Price discovery is sensitive to many factors. For a specific execution venue, the following inputs may drive the price discovery mechanism:

  • Number of buyers
  • Number of sellers
  • Number of items for sale in that trading period
  • Number of recent sales or purchase price (this is the price at which items traded)
  • Current bid price
  • Current offer price
  • Availability of funding
  • Obligations of participants (e.g. regulation, exchange rules, Fund Policy)
  • Cost of execution (market fees and tax)
  • Cost, Availability and Transparency of pricing information in current and other execution venues.

The cost of execution applies to all markets, and even a street market trader may have to pay to have a stall or invest time walking to a village market. They are not costs of production but a cost incurred to access the execution venue.

Price discovery is a summation of the total market’s sentiment at a point in time: a multifaceted, aggregate view on the future. It is how every price in every market is determined. The market price is important as it is a factor in the pricing at off market execution venues and direct and indirect derived products. For example, the price of oil has a direct bearing on the cost of tomatoes in cold climates.

Market rules set the times and duration for trades and settlement. Some markets may not have many participants as the assets being traded do not have much appeal (the formal term is market interest in which participants express interest in the underlying asset). Such markets are often called illiquid, for example minor currencies. In illiquid markets, price discovery might take place at a predefined auction time or even whenever participant wants to trade. In such cases there may be no executions for days or months. In such examples there is no price discovery for long periods so the last traded price is used. This can have significant risk as the market for the illiquid may have moved. Another characteristic of illiquid markets is that the cost of trading can be higher due to the lack of competition.

In a dynamic market, the price discovery takes place continuously while items are bought and sold. The price will sometimes fall below the duration average and sometimes exceed the average as a result of the noise due to uncertainties, and transient changes in supply caused by the act of buying and selling: trading. A closed market has no price discovery; the last trade price is all that is known. It is common in some markets not to use the actual last traded price but some sort of average / weighted mean. This is to prevent price manipulation by the execution of outliers on or at market close. One side effect of this practices is that market close prices are not always available at market close, indeed even after the official market close is published, it is possible for “corrections” to be issued later still.

Usually, price discovery helps find the exact price for a commodity or a share of a company. Price discovery is used in speculative markets which affect traders, manufacturers, exporters, farmers, oil well owners, refineries, governments, consumers, and speculators.