Seasonal Price Movements and Unit Roots in Indonesian Rice Market Integration

The use of cointegration techniques to measure market integration and Granger Causality to establish the direction and strength by which markets influence each other is taken a stage further. The importance of first testing whether trends and cycles in the price series are deterministic or stochastic processes is pointed out. This in turn establishes the appropriate form of equations to be used for measuring market integration, both over the long run trend of prices and within cycles. Testing the nature of the process is particularly important for the treatment of seasonality since dummy variables, commonly used in regression equations to allow for seasonal and other cycles, is only valid for deterministic processes. The treatment of seasonality explained here also provides new opportunities for investigating the nature of integration over cycles. The techniques are applied to data for the Indonesian rice market where both trend and seasonal processes are shown to be stochastic. Integration is shown to occur through the CPI which is "caused" by the main supplier and "causes" the prices in other markets. (N.B. Abstract contains 174 words) 1 Carol Alexander is professor of finance and chair of the risk management group at the ISMA centre, Reading University (www.ismacentre.reading.ac.uk). John Wyeth is a consultant in agricultural economics who works mainly in developing countries. Many thanks to the Indonesian Food Logistics Agency (Bulog) for their support in addressing the question dealt with in this paper while he was policy advisor there funded by the British Overseas Development Administration and to the Institute of Development Studies at the University of Sussex where he was a Visiting Fellow whilst working on an earlier version of this paper. The opinions expressed in the paper are those of the authors and should not be attributed to any of the institutions mentioned. Seasonal Price Movements and Unit Roots in Indonesian Rice Market Integration © Carol Alexander and John Wyeth, 1995 2 CONTENTS Abstract 3