Crop with no futures: explaining the absence of derivatives trading in the Rice Market

Abstract

This thesis seeks to explain the near absence of derivative contracts in the rice market, in the light of these instruments’ prominence in other agricultural commodity markets. To do so, I compare rice with three of these commodities – wheat, sugar and coffee – identifying differences preventing or encouraging the financial development of rice and not of others. I explore the development of derivatives markets in four geographic case studies: the USA, Thailand, Japan and Vietnam. To answer the research question, I primarily use interview data of industry stakeholders in the four markets examined, such as farmers, millers, traders, analysts and contract engineers. The research determines why rice stands as an exception in regard to financial development and this case provides in return a new approach to the development of derivatives market. The study challenges the common argument of the existing literature that a single factor is enough to impede the development of a futures market. In the case of rice, it is the accumulation of obstacles that supress futures trading. I argue through this thesis that the propensity of market participants to get involved in a derivative market is key to the outcome of financial development. In rice, two types of factors deter the participation of key stakeholders in the building of financial markets: (i) their risk profile, affected by factors such as their ability to store the commodity and the prevalence of their crop risk over price risk; (ii) the potential weakening of their market power by futures contracts. Such power can be the result of the profile of the supply chain, but its most important driver is the opacity of the rice market. Three other factors, more systemic, appear particularly important: (i) the heavy politicization of the rice market disrupts the nature of the risk that can be hedged and traded with futures contracts; (ii) the geography of the physical market does not favour financial development. Derivatives markets find their roots in the financially sophisticated economies of developed countries, before expanding onto the markets of developing countries. However, for markets that are almost exclusively situated in developing countries, like rice, financial development struggles to take place endogenously: (iii) the fragmentation of the market into different varieties is not conducive to the construction of a standardised market. Finally, this thesis highlights the importance of the link between OTC markets and futures markets to the success of financial development.