How Market Efficiency and the Theory of Storage Link Corn and Ethanol Markets

Mindy L. Mallory, Dermot J. Hayes, Scott H. Irwin
December 2010  [10-WP 517]

In this article we use the theories of market efficiency and supply of storage to develop a conceptual link between the corn and ethanol markets and explore statistical evidence for the link. We propose that a long-run no-profit condition is established in distant futures markets for ethanol, corn, and natural gas and then use the theory of storage to define an inter-temporal equilibrium among these prices. The relationship shows that under certain conditions, future price expectations will influence current spot prices and that a short-term relationship between input and output prices will exist. This short-term relationship will contain fixed costs. We demonstrate validity of the theory using a structural price model and then by means of time-series techniques.

Keywords: arbitrage, cointegration, corn, energy, ethanol, futures, price-analysis, storage.

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