1. Tools to measure priceTransmission frominternational to localmarketsPresented by: Nicholas Minot International Food Policy Research Institute www.agrodep.org AGRODEP Workshop on Analytical Tools for Food Prices and Price Volatility June 6-7, 2011 Dakar, Senegal Please check the latest version of this presentation on: http://www.agrodep.org/first-annual-workshop

2. Outline What is price transmission? p Why does price transmission occur (nor not)? Review measures of price transmission Simple percentage changes Correlation analysis Regression analysis Co-integration analysis Threshold auto-regresion R Results of study of impact of world markets on African lt f t d f i t f ld k t Af i food prices Conclusions

3. Whatispricetransmission?What is price transmission? Price transmission is when a change in one p g price causes another price to change Three types of price transmission: Spatial: Between two markets for same commodity Price of maize in South Africa price of maize in Mozambique Vertical: Between two points in supply chain Price of wheat price of flour C Cross-commodity: B t dit Between t two commodities diti Price of maize price of rice

4. Whyisitusefultostudypricetransmission?Why is it useful to study price transmission? Study of price transmission helps to understand causes of changes in prices necessary to address root causes prices, Example: If little price transmission from world markets, then trade policy will not be effective in reducing volatility Study of price transmission may help forecast prices based on trends in related prices Example: If changes in soybean prices transmitted to sunflower markets, then soybean futures markets may predict sunflower prices Study of price transmission helps diagnose poorly functioning markets Example: If two markets are close together, but show little price transmission, thi may indicate problems with t t i i this i di t bl ith transportation t ti network or monopolistic practices

5. Whydoesspatial pricetransmissionoccur? Why does spatial price transmission occur? Maize prices in Maputo & Chokwe p p S ti l price Spatial i 16 transmission occurs because of flows of 14 goods between 12 markets & spatial arbitrage 10 If price gap > 8 marketing costs, Maputo 6 trade flows will narrow gap g p 4 If price gap < Chokwe 2 marketing cost, no flows 0 Therefore, price gap 1.0

11. Howispricetransmissionmeasured?How is price transmission measured? There are several methods four are discussed here 1. Ratio of percentage changes between two time periods 2. Correlation coefficient 3. 3 Regression analysis 4. Co-integration analysis 5. Threshold auto-regression model

12. 1.Ratioofpercentagechanges1. Ratio of percentage changes Ratio of percentage changes between two time p p g g periods PriceofmaizeinDares Salaam PriceofUS#2YellowMaize US$/ton US$/tonJune 2007 120 165June2008J 2008 239 287% Change 99% 74% Elasticity of transmission is 1.34 (= .99 / .74) Note that both prices increased by about $120/ton

13. 1.Ratioofpercentagechanges1. Ratio of percentage changes example Disadvantage: Crude method, only uses two points in g , y p time and does not take trends into account 450 Maize,DaresSalaamwholesale , 400 Maize,USNo2yellowmaize,FOBGulf 350 300 ton) Price(US$/metrict 250 200 150 100 50 0 May06 May07 May08 May09 Mar06 Mar07 Mar08 Mar09 Sep06 Sep07 Sep08 Sep09 Jul06 Jul07 Jul08 Jul09 Nov06 Nov07 Nov08 Nov09 Jan06 Jan07 Jan08 Jan09

14. 2.Correlationcoefficient 2. Correlation coefficient Indicates the degree of relatedness of two variables Two related measures Pearson correlation coefficient = r Coefficient of determination = R2 = r * r Both range from 0 (no relation) to 1 (perfect relation) 700 1000 900 600 R 0.9027 R= 0.9027 800 700 R=0.1191 Medium 500 400 600 P2 correlationP2 500 300 400 200 300 700 200 100 100 600 R=0.4812 0 0 500 0 100 200 300 400 0 100 200 300 400 400 P2 P1 P1 300WeakcorrelationW k l ti 200 Strongcorrelation Strong correlation 100 0 0 100 200 300 400 P1

15. 2.Correlationcoefficient2. Correlation coefficient Advantage Easy to calculate (can use Excel) Easy to understand (R2 as pct explained) Disadvantages Only takes into account two prices, excludes effect of other p prices and variables Only considers relationship between prices at same time, does not take into account lags in effect Cannot identify causality Misleading results if prices are non-stationary

16. 3.Regressionanalysis3. Regression analysis Multiple regression analysis: p g y Y = a + b1*X1 + b2*X2 + = a + biXi + Advantages Gives information to calculate transmission elasticity Can test relationships statistically Can take into account lagged effects, inflation, and seasonality can analyze relationship of > 2 prices Disadvantages Difficult to identify causality Misleading results if prices are non-stationary non stationary

17. Non stationarity Nonstationarity Definition What is a non-stationary variable?Stationary variable Y Non-stationary variable YYt = a + Yt1 +bXt + t where||