Mandatory Price Reporting, Market Efficiency, and Price Discovery in Livestock Markets

ContentsApproved by USDA’s World Agricultural Outlook BoardUnited StatesDepartmentof Agriculturewww.ers.usda.govA Report from the Economic Research ServiceAbstractAs the use of alternative marketing arrangements (AMAs) such as forward contracts and formula pricing has expanded in livestock markets since the early 1990s, and nego-tiated cash markets have become less commonly used to arrive at transaction prices, questions about price discovery and market efficiency have arisen. Congress passed the Livestock Mandatory Reporting Act (LMRA) in 1999 in response to concerns about a lack of public disclosure regarding AMAs, as well as concerns about concentra-tion in the meat packing industry. The LMRA introduced mandatory price reporting (LMR) of most livestock transactions to improve the flow of transaction information in the market place and enhance price discovery, and to replace the previous system (which had relied on voluntary reporting from cash market transactions). Renewed and amended in 2005 and 2010, the LMRA is up for renewal again in 2015. This report analyzes livestock market price behavior and price discovery before and after imple-mentation of LMRA, and finds that the increased flow of market information with LMR better informs the broader market. Analyses also indicate that futures and cash prices for hogs respond and adjust to new information (market efficiency) better in the LMR era, with an increased role for cash markets in price discovery. Keywords: Beef, Cattle, Causality, Error Corrections Model, Futures Prices, Hogs, Livestock Mandatory Reporting, Livestock Mandatory Reporting Act, Livestock sellers, Meatpackers, Pork, Price Discovery, State-Space Model, Vector autoregressionAcknowledgmentsThe authors would like to thank Jim MacDonald and Maurice Landes of USDA, Economic Research Service (ERS); Shayle Shagam, Livestock Chair of the World Agricultural Outlook Board; and peer reviewers Warren Preston of USDA, Agricultural Marketing Service; Steve Koontz of Colorado State University; and Ted Schroeder of Kansas State University. We also thank ERS editor Susmita Pendurthi and ERS designer Cynthia A. Ray.LDPM-254-01September 2015Kenneth H. Mathews, Jr., Wade Brorsen, William F. Hahn, Carlos Arnade, and Erik DohlmanMandatory Price Reporting, Market Efficiency, and Price Discovery in Livestock MarketsIntroduction . . . . . . . . . . . . .1U .S . Federal Government Intervention in Livestock Marketing . . . . . . . . . . . . . .2Livestock Pricing Methods . . . . . . . . . . . . . . . .4Highlights of the Mandatory Price Reporting Literature . . . . . . . . . . . . . . .8An Overview of Recent Cattle and Hog Transaction and Market Data . . . . . . . . . . .11The Impact of Mandatory Price Reporting on Cash and Futures Market Interactions . . . . . . . . . . . .16The Impact of Livestock Mandatory Price Reporting on Cash Price Behavior in Cattle and Beef Markets . . . . . . .25Findings and Implications . . . . . . . . . . . .28References . . . . . . . . . . . . .30Appendix A—An Error Correction Model to Test Price Discovery . . . . . . . . .35Appendix B—The VAR Forecasting Model . . . . . . .42 1 Mandatory Price Reporting, Market Efficiency, and Price Discovery in Livestock Markets, LDPM-254-01 Economic Research Service/USDAMandatory Price Reporting, Market Efficiency, and Price Discovery in Livestock MarketsIntroductionIn 1999, the U.S. Congress passed the Livestock Mandatory Reporting Act (LMRA), which required mandatory reporting (LMR) of market transaction data, including price and quantity infor-mation. The LMRA was implemented in April 2001, renewed and amended in 2005 and 2010, and is set to expire on September 30, 2015. The LMRA was (U.S. Senate Report 106-168, 1999, p. 1): “...to establish a program of information regarding the marketing of cattle, swine, lambs, and products of such livestock that: provides information that can be readily understood by market participants; improves the U.S. Department of Agriculture’s price and supply reporting services; and encourages competition in the marketplace for live-stock and livestock products.”Since an earlier evaluation of the first version of the LMRA (Perry et al., 2005), significant data have accumulated on prices for cattle, hogs, beef, and, since 2013, pork. Perry et al. (2005) provided detail on the issues that drove the switch to mandatory reporting, focusing on cattle and beef, and showed that the same model could be used to forecast cattle and beef prices both before and during LMR, implying little change in how market prices were set before and during LMR. LMR has now been in effect for more than 15 years. With the LMRA set to expire on September 30, 2015, a number of questions arise. What insights can be obtained from the current and prior economic literature regarding the flow of information in markets with LMR? What can data tell us about the effects of LMR on market efficiency during the last decade and a half, and w