The Effect of the Dispute between the EU and the US over Genetically Modified Organisms in Food and Feed on Financial Markets

Fahbereih Politik-und

Verwaltungswissenshaft

The Eet of the Dispute between the EU and

the US over Genetially Modied Organisms

in Food and Feed on Finanial Markets

Diplomarbeit

Mai 2007

Erstgutahter: Prof. Dr. Gerald Shneider

Zweitgutahter: Prof. Dr. Christoph Knill

Arbeitvorgelegt von:

David Lehmkuhl

Remisbergstrasse 60

8280 Kreuzlingen

Shweiz

Email: David.Lehmkuhluni-konstanz.de

Matrikelnr. 01/496686

Konstanzer Online-Publikations-System (KOPS)

URL: http://www.ub.uni-konstanz.de/kops/volltexte/2007/3204/

URN: http://nbn-resolving.de/urn:nbn:de:bsz:352-opus-32043

Diese Studie untersuht die Auswirkungen des Handelsstreits zwishen der

USAundderEUübergentehnishveränderteOrganismen(GVO)inLebens-

und Futtermitteln auf Finanzmärkte. Die EU hat Anfang der 90er Jahre

begonnen, die Verbreitung, Verfolgbarkeit, Vermarktung und Kennzeih-

nung von GVO zu regulieren, wobei eine Minderheit im Europäishen Rat

eine Moratorium für die Zulassung neuer GVOs im Jahr 1998 durhset-

zte. Damitshloss sih der europäishe Markt weitgehend für gentehnish

veränderte Erzeugnisse. In der EU gab es keinen Anbau von gentehnish

verändertenPanzen,wohingegen FarmerindenUSAbereits imJahr 1996

bis zu 54 Prozent gentehnish veränderte Panzen anbauten. Exporte in

dieEU waren dadurh gefährdet.

Die Arbeit untersuht mit Hilfe der Ereignisanalyse aus der Finanz-

ökonometrie, wie Händler an Warenterminbörsen auf politishe Ereignisse

des Koniktes reagiert haben. Dabei unterstellt die Arbeit, dass die eu-

ropäishe Politikeine UmverteilungaminternationalenMarktverursahte;

Regionen,dieweitgehendaufGentehnikverzihtethatten,habenprotiert,

während Regionen, die auf die Gentehnik gesetzt hatten, mit fallenden

Absätzen rehnen mussten. Um diese Hypothese zu untersuhen, werden

Sojabohnen-Futuresaus denUSA undMais-FuturesausEuropaanalysiert.

Der Untersuhungszeitraum sind die Jahre 1990 bis 2006. Ih kann nah-

weisen, dass der amerikanishe Gütermarkt negativ auf Nahrihten über

strikte Regulierungen in Europe reagiert hat, wohingegen es Hinweise da-

rauf gibt, dass der europäishe Markt davon protiert hat. Als die USA

eine Klage bei der Welthandelsorganisation eingereiht haben, stiegen die

Preise in den USA. Shlussfolgerung ist, dass Händler an Warentermin-

börsen kalkulieren, wer der Gewinner und wer der Verlierer von De-Fato-

Prokektion ist. Somit geben Finanzmärkte Auskunft über die erwarteten

Eekte von politishen Entsheidungen.

ThisstudysrutinisestheeetsofthedisputebetweentheEuropeanUnion

and the United States over Genetially Modied Organisms (GMOs) in

Foodand Feed on nanial markets. The European Union introdued be-

tween 1990 and 2006 tightregulations of GMOs while barringany new ge-

netially modied rops fromentering the European market between 1998

and 2004. Farmers in the US had adopted genetially modied rops to a

large extent and thus ould not export these to the EU any more. I show

thattradersatommodityderivativeexhanges updatedtheirexpetations

of pries upon events of the trade dispute. Using event studies and a time

series regression I demonstrate that news from EU institutions signalling

the losingof the European markettogenetially modiedrops dereased

priesof US soybean futures and inreased pries ofEuropean orn futures

on average. When the US led a omplaint that the WTO, US soybean

pries rose.

Harold Lasswell, 1950

Typset inL A

T

E

X, Roman,12pt

List of Tables vii

List of Figures viii

List of Aronyms ix

Aknowledgments x

1 Introdution 1

2 A short story of a transatlanti dispute 5

2.1 Bakgrounder on Biotehnology . . . 5

2.2 Putting GMOs in a Corset: Europe's Regulation. . . 7

2.2.1 Food Sandals in Europe . . . 7

2.2.2 GMORegulationin Europe . . . 8

2.3 Overthe Atlanti: the US Response . . . 12

2.4 Redistribution due toRegulation? . . . 14

3 Literature Review 16 4 Theory 22 4.1 Theory of FuturesPriing . . . 22

4.1.1 Cost-of-Carry Model . . . 24

4.1.2 Theory of Normal Bakwardation . . . 26

4.1.3 CapitalAsset PriingModel . . . 27

4.2 An Assumption: Eient Finanial Markets . . . 28

4.2.1 Eient Market Hypothesis . . . 28

4.2.2 Behavioural Finane . . . 30

4.3.1 The Prie of AgriulturalCommodity Futures . . . . 36

4.3.2 Volatility of AgriulturalCommodity FuturesPries . 40 5 Researh Design 42 5.1 Case Seletion . . . 42

5.2 Dependent Variable . . . 43

5.2.1 The Soybean Futures . . . 44

5.2.2 The Corn Futures . . . 46

5.3 Independent Variable . . . 48

5.4 ControlVariable `The Market' . . . 51

5.5 Methodology . . . 53

5.5.1 Event lustering . . . 53

5.5.2 Event Study Approah . . . 55

5.5.3 Time SeriesAnalysis . . . 61

6 Data Analysis 69 6.1 Case Studies. . . 69

6.2 Mean Analysisusing Event Study Approah . . . 74

6.2.1 RegulatoryNews fromthe EU . . . 74

6.2.2 RegulatoryNews fromMember States . . . 79

6.2.3 The WTO Complaint. . . 81

6.3 Time Series Regression . . . 83

6.3.1 Soybean Futures . . . 83

6.3.2 Corn Futures . . . 84

6.4 Disussion of Results . . . 90

7 Conlusion and Outlook 92

Bibliography 105

Appendix 1: List of Events 106

Appendix 2: Repliation 110

5.1 Desriptive Statistisof the TimeSeries . . . 48

5.2 Numberof Events . . . 51

5.3 Pairwise orrelationsof Returns . . . 52

6.1 Event Studies . . . 71

6.2 Testing Contra-GMO RegulatoryNews fromthe EU . . . . 76

6.3 Testing Pro-GMORegulatory News from the EU . . . 77

6.4 Testing PivotalDeisions . . . 78

6.5 Testing Adaption of Legislation . . . 78

6.6 Testing Contra-GMO Member State Announements . . . . 80

6.7 Testing Pro-GMOMemberState Announements . . . 81

6.8 Testing the WTO Complaint. . . 82

6.9 GARCH of Soybean Futures Returns . . . 85

6.11 GARCH of CornFuturesReturns . . . 87

2.1 EU Share of US Corn and Soybeans Exports . . . 15

4.1 EU Consumption of Protein-RihFeed Materials. . . 38

5.1 SpikeGraph of Soybean Futures Returns . . . 45

5.2 SpikeGraph of Corn Futures Returns . . . 46

5.3 Prie of the Soybean and Corn FuturesContrat . . . 47

5.4 Clustering of Events . . . 55

5.5 Average Intra-Monthly Standard Deviationof Futures Returns 63 6.1 Abnormal Returnsaround Counil Deision toHaltApprovals 70 6.2 CAARs of Contra-GMO RegulatoryNews . . . 75

6.3 CAARs of Pro-GMO RegulatoryNews . . . 75

6.4 CAARs of PivotalDeision inEuropean LegislationProess 77 6.5 CAARs of Adoptionof European Legislation . . . 77

6.6 CAARs of Contra-GMO RegulatoryNews by Member States 79 6.7 CAARs of Pro-GMO RegulatoryNews by MemberStates. . 79

6.8 CAARs of WTO Complaint . . . 82

ARCH Autoregressive ConditionalHeteroskadastiity

BSE BovineSpongiform Enephalopathy

CAAR Cumulative Average AbnormalReturn

CBOT ChiagoBoard of Trade

CME ChiagoMerantile Exhange

EMH Eient Market Hypothesis

EU European Union

GARCH GeneralAutoregressive Conditional Heteroskedastiity

GATT GeneralAgreement on Tarisand Trade

GM GentiallyModied

GMO GenetiallyModiedOrganism

LB Ljung-Box Statisti

OLS OrdinaryLeast Squares

SPS Sanitary and Phytosanitary Measures

UN United Nations

US United States of Ameria

USD United States Dollar

WSJ Wall Street Journal

WTO World Trade Organization

I thank Prof. GeraldShneider forthe supervision throughoutwritingthis

thesis and Prof. Christof Knill for being the seond supervisor. Mihael

Behtel provided the ontat to Roland Füss und Zeno Adams who were

kindenoughtoretrievethetimeseriesfromDatastreamforme. Ithankthe

library sta of the John F. Kennedy Institute, Freie Universität Berlin for

assistaneintheirarhive,Prof. WinfriedPohlmeierforeonometriadvie

andGabiRuoforsharingherdo-le. IamindeptedtoChristofShwenkel,

JosephFizzarotti,NoraRöhnerand SashaMessmer forhelpfulomments.

Any remaining errors are of my responsibility. I gratefully aknowledge a

sholarship by the Heinrih-Böll Foundation throughout my studies. The

work isdediated to Sara.

Introdution

The United States of Ameria and good old Europe sometimes quarrel.

They biker about limate hange or whether to go towar with a foe, and

about plain old trade politis. While eonomi ooperation among nation

states, umulating in the foundation of the World Trade Organization in

1995,hasmade tarisandquotas omeoutof fashion,non-taribarriersto

tradehaveremained anissueand trade poliyhas `shiftedbehindborders'.

ThedisputebetweentheEUandtheUSovergenetiallymodiedorganisms

(GMOs)infoodand feedisanexamplewhere`national'produtregulation

impededinternationaltradeandbeameanissueinbilateralrelations. This

study is an attempt to show the reperussions of suh a dispute by using

nanialmarketsasamirrorof redistributiveeetsof shiftingtradeows.

There is a long debate in the politial sienes about whether states

an ooperate in the realm of international eonomis.. Realists have de-

sribedeonomiooperationasdiulttoimpossibleinaworldofanarhy

andstatesattentivetotheirsurvival(Morgenthau1967,Waltz1979). States

annotaept that their ounter may gain more fromfree trade relativeto

their own gains beause the opponent ould use the eonomi advantage

to arm himself and threaten the trading partner. In ontrast, liberalists

have seen eonomi ooperation as a viable tool of states to enhane their

own well-being. They fous on absolute gains and on whether states an

ommitthemselvestointernationalinstitutions(f.Kant1949 (1795)). Po-

litial eonomy breaks down the state and interprets trade poliy as the

outome of voters preferenes represented by parties and interest groupin-

uene (Milner 1999). Redistribution is onstitutive for politis and thus

trade poliy may be analysed in terms of winners and losers. In the same

line,the WallStreetJournaldenounedEuropeforusingthe fearofGMOs

as a pretext for proteting its agriultural setor. However, opinion sur-

veys showed that the majority of European onsumers has found GMOs

in food unaeptable (Eyk, Gaskell & Jakson 2004). Meins (2003) nds

the European regulation not driven by the agriultural setor but more by

strong environmental non-governmental organisations and publi opinion.

So, ultimately, this work is motivated by the question why Europe passed

aregulation that was so strit that itfuntioned asa tradebarrier.

Genetially modied rops were introdued at the world market at

the beginning of the 1990s, yet the response was very diverse aross the

Atlanti. The US Food and Drug Administration delared in 1993 that

the proess of food prodution is irrelevant. Whether by GMOs or non-

GMOs, if the objetive harateristis of the food are essentially the same

and therefore food derived from or ontaining GMOs is subjet to same

regulations as ordinary produts. In ontrast, the EU has regarded food

derived fromGMOsorgenetiallymodiedplantsasa`novel'produtwith

anunknown risktohumansand theenvironment. Startingin1990,the EU

has set up a new regulatory framework. While the Commission favoured

a pragmati approah, a minority in the Counil installed a moratorium

on the approval of any GMOs in food or feed in 1999. While remaining

patientinthe beginning, theUSgot inreasinglyagitatedand ledaWTO

omplaintin 2003. After having established anew approvalproedure, the

approval proess restarted in 2004 and the 2006 WTO ruling that the EU

ban was againsttrade rules remained without onsequenes.

Due to the fat that the EU grew virtually no GM rops while the

USfarmers had adopted them rapidly,54 perent of the soybean and 25 of

orn grown in the US in1996 was genetially modied(Dohlmann, Hall&

Somwaru2002, 108), theban of GMrops hada de fatoprotetivenature

for European agriultural markets and ursory evidene suggests that the

onitdisruptedAmerianagriulturalexportstoEuropeonalargesale.

The share of soybeans exports to the EU from the US fell fromaround 45

perent in 1994 to 25 perent at the end of 1998 and orn exports fell by

$ 400 million between 1998 and 2000 (Lin, Chambers & Harwood 2000,

29-30).

Thelong-termguresspeaktheirlanguage,butthereisnoausal link

betweenregulationandtradeguresofommodities. Analysingommodity

derivatives oersan avenue linking European regulation to US ommodity

markets. Somestudieshavebeenpublishedonthereationofnanialmar-

study takes politial events as ause although it laks a politial eonomy

perspetive, too. Dohlmann,Hall & Somwaru (2002) analyse how bioteh-

nology ompanies' stoks reat to politial events. However, this approah

fousesonthelosersoftightregulationagain. Nosientistudyhasyetat-

temptedtounearth theeet ofregulationonthepotentialwinner,namely

European agriulturalmarkets. Again, ommodity derivativesan be used

foranswering thisquestion. Priesshouldriseif supplydereases aording

to the simple priniple of supply and demand. If the US supply was shut

out of the European market, pries should have risen in Europe, at least

temporarily,unlesstherewasaperfet substitute. Tradersould havespe-

ulatedonthis eet. Srutinisingthe European ommoditymarketforthis

is novel.

In this researh endeavor I will employ the tools of nanial eono-

metris, namely the event study approah and a time series analysis, to

test whetherevents ofthe disputehadasigniantimpatonpriesofsoy-

bean futures from the US and on orn futures from Europe. Time series

tehniques with a onditional variane are applied to study the eet of

exogenous eets onthe variane,i.e. whether politialevents inreased or

dereased the unertainty in agriulturalmarkets.

IolleteddataonthepassingofregulationofGMOsinEurope. How-

ever, studies have repeatedly failed to detet the impat of legislation be-

ause tradersantiipated the eet beforehand. Therefore, I havedeteted

at what point the piee of legislation passed its nal veto point. Further-

more, I have onduted a ontent analysis of the Wall Street Journal, US

EastCoastedition,toestablishwhennewsofregulatoryeventsreahedthe

market and whether this aused any reations. Furthermore, I reorded

when the US led itsomplaint atthe WTO.

IndthattheUSommoditymarketreatednegativelytothepassing

ofEuropeanlegislationofGMOs andnewsabout the legislation. The pass-

ing of the nal veto point did not ause any reations. At the same time,

thereis evidenethat theEuropean marketreated positivelytonews that

regulation would ban US agriultural imports. This is possibly due to the

antiipated substitution eets.

This thesis is strutured asfollows: Chapter 2 gives ashort overview

onbiotehnologyand reountsthe development of the treatmentof GMOs

in Europe and, in turn, the US response to European regulation. Some

desriptive evidene is given on the eets of the dispute on agriultural

trade. Chapter 3 providesaliterature review ofthe politialeonomy of-

nanialmarkets and,inpartiular,the literatureonpolitialredistribution,

on regulatory deisions and nanial markets and the dispute over GMOs

in food and feed. This is followed by the theoretial bakground of this

study, namelythe eientmarket hypothesis and theory of futures priing

in Chapter 4. Subsequently, I develop my theoretial modeland formulate

my hypotheses. In Chapter 5, I present my researh design, in partiular,

how the data were assembled and whih statistial tehniques were em-

ployed. Chapter 6 presents and disusses the results of the data analysis

while Chapter 7onludes and givesan outlook overpossibleextensions of

this study.

A short story of a transatlanti

dispute

ThisthesisstudiestheeetsofthedisputebetweentheEUandtheUSover

genetially modied organismsin food and feed on nanialmarkets. The

present hapter provides a short overview of biotehnology in Setion 2.1.

The development of regulation of genetially modied organisms (GMOs)

in Europe is reounted in Setion 2.2 and the US response is desribed in

Setion2.3. Setion2.4providessomeanedotalanddesriptiveinformation

of the eets of the dispute.

2.1 Bakgrounder on Biotehnology

Before getting to the substane of this study, one needs to know what ex-

atly is meant by `geneti modiation' . Evolution is geneti modia-

tion. Evolution is not planned and the deliberate geneti modiation is

slow. Mankind utilized geneti modiation ever sine starting farming.

Certainplantsbear favourableharateristiswhihare determined by the

genome. By keeping ertain plants beause of its harateristis, humans

have hanged the genome of rop plants by and by. While this breed-

ing proess took generations, ross-breeding tehniques have onsiderably

aelerated the proess of developing ertain harateristis in plants, al-

thoughthe genomeisnotaltereddiretly. Thetehnologialprogressofthe

lastdeadesmadeitpossibletohangethegenomediretly,whihpromises

to be faster and more preise in inserting preferable harateristis. More

importantly,itallows rossingthe`speies barrier',i.e. transferring hara-

teristis of one speies to the other. Forinstane, DNA of bateriaan be

passedontoplants(Pistorius&vanWijk1999,109). Potentialappliations

areplantswhihproduemediineforanimalstoget prophylatilyintheir

fodderor plantswhihprodue a toxin fatalto aparasite. One exampleis

Researh on geneti modiation of organisms has been ongoing for

deades. The proess began withthe disoveryof DNA, and basi researh

onthe genetimodiationoflivingorganismsouredroughlyintheearly

nineteenthenturywhile itgathered paein the 1960sresultingin therst

reombinantbateria(E.oli)expressingafroggenein1973(seeBud(1993)

for a history of biotehnology). First appliations and most researh were

onduted for pharmaeutial purposes. The prodution of insulin is an

example of biotehnology in pharmay. Then agriultural ompanies be-

ame interested in biotehnology and pharmaeutial rms disovered an

additional appliation for their biotehnology knowledge. While geneti

modiation for pharmaeutial purposes has gone largely unnotied, the

publidebateongenetiengineeringfousesonitsagriulturalappliations.

Theaeptaneratesbetweenpharmaeutialandagriulturaldierwidely.

The rstgenerationofmodiationsforagriulturalpurposesonen-

trated more on the needs of farmers and foused oninput traits of plants.

For instane, plants were made resistant against ertain herbiides. The

farmer ould thus spray a eld of genetially modied (GM) rop and kill

all the weeds without destroying the rop. Agriultural ompanies sold

not only the plant but also the herbiide. Another important eld is the

resistane against ertainpests, for instane, the orn borer.

The seond generation of geneti modiations foused on output

traits, therefore also alled `value-enhaned rops'. For instane, Calgene

In. developed the`FlavrSavr'tomatothat wouldremainfreshforalonger

periodthannormaltomatoesandtastebetter,aordingtoCalgeneIn. It

was,however, onlyavailableto onsumers fora short time. Atually, there

are only two seond generation produts on the US market, namely olei

soybeans and laurateanola (Jeerson-Moore 2005).

Therst generationtraitswere attahedtohemialengineering. The

seondgeneration was independent of hemialompanies and, asa result,

the idea of a `life siene' ompany ame up, ombining agriultural and

pharmaeutial ativities based on the same knowledge of how to mod-

ifythe geneti informationof an organism. The shiftresulted in a wave of

mergerswhereompaniessuhasAventisemergedorDowChemialbought

biotehnology ompanies. However, when the trend went against agro-

biotehnology at the end of the 1990s, biotehnology ompanies spun o

their agro-biotehnology divisions beause their unertain prospets pulled

down the share prie (Pollak & Shaer 2000, 50). For instane, Phar-

maia bought Monsanto only to get its pharma division and spun o the

agri-biotehnologydivisions(WSJ,21Deember1999). MonsantoandSyn-

genta, based in the US and Switzerland respetively, are the two large

ompanies left devoted solely to agro-biotehnology (f. also European-

Commisson 2000).

2.2 Putting GMOs in a Corset: Europe's Reg-

ulation

Everystudy onEurope's septiismofagro-biotehnologystartsowithre-

ferringtothemostreentfoodsandalsinEuropewhihoinedonsumers'

attitudetowards GMOs infood and feed and sodo I.

2.2.1 Food Sandals in Europe

The most prominent `sandal' in food safety is the BSE risis. Bovine

Spongiform Enephalopathy (BSE), a deadly disease aeting the brain of

attle, was rst deteted in 1988 in the UK and the number of onrmed

ases rose to around 35000 by 1992 (Henson & Mazzohi 2002, 371). Al-

thoughmediaoverage startedin1989, the shokto onsumersame when

the UK government announed on 20 Marh 1996 that there was a possi-

ble onnetion between the fatal CreutzfeldtJaob disease and BSE. The

government would not rule out that humans ould be infeted by eating

beef of infeted attle. The lax response in the beginning and a lak of

tests allowed BSE to spread aross Europe. Although the number of on-

rmedCreutzfeldtJaobasesreahedamoderate25by theyear 2000,the

damagewasdone and onsumersin Europeunsettled. Marks &Kalaitzan-

donakes(2001)ondutedaontentanalysis ofthe mediaoverageof agro-

biotehnology in the Daily Telegraph (UK) and nd a onnetion between

the septiism towards agribiotehnology and the BSE risis.

In May 1999, dioxin found its way into the food hain in Belgium

when hikens ate ontaminated feed. Dioxin is highly noxious and food

produts needed to be realled aross Europe, and pigs and hikens were

slaughtered.

The foot-and-mouthdisease broke out in Great Britainin the spring

of 2001. In an attempttohalt the epidemi, over seven millionsheep were

slaughteredalthoughontinentalEuropewitnessedonlysporadiases. The

issue dominated the Britishmedia and toa lesser extent the media onthe

ontinent untilthe terroristattaks inthe US inSeptember 2001 attrated

widerattention (thediseasewasunderontrolby Otober2001inBritain).

Thestringof`sandals'reatedonsiderabledistrustinEuropeanonsumers

that their food was safe and that governments ensured its safety. This

distrustsigniantly shaped peoples' attitudes towards GMOs in food and

feed.

2.2.2 GMO Regulation in Europe

ThetopiofthisstudyistheregulationpassedbytheEuropeanUnionwith

regard to release, ommerialisation, labelling and traeability of produts

produedoforfromplantswithdeliberatelymodiedDNAand bateriaas

aningredientoranaid. Inthebeginning,theissuefellunderthe auspiesof

theEnvironmentalDiretorateGeneralofthe EuropeanCommission 1

while

itmovedtotheDiretorateGeneralHealthandConsumerProtetion. Reg-

ulation was in the beginning made for regulating the releas of genetially

modiedplantsintotheenvironmentduringeldtrials. Asthe thetehnol-

ogyentered the marketonaommerial saleonsumer protetion beame

more the fous of GMO regulationand the EU pursues now an`integrated

approah to food safety' meaning the whole food hain is regulated from

the perspetive of onsumer protetion 2

.

The European Union passed its rst piee of regulation regarding

GMOs in 1990 (24 April 1990). Diretive 90/220/EEC regulates the de-

liberaterelease of GMOs intothe environment. It standardiseshowGMOs

maybereleasedintotheenvironmentforresearhanddevelopmentpurposes

(PartA)andalsostipulatesthatGMOsrequireanapprovalforommerial-

isationintheEU(PartC).Althoughthediretivewasmeanttoregulatethe

environmentalimpatofGMOtheDiretorateGeneralXI (Environment,

Nulear Safety, and Civil Protetion) wrote the text , it also overed the

marketing of produts derived from GMO. Therefore, it applied to GMO

in food and feed until 1997 when Counil Regulation 258/97 was passed.

1

SeeKnill (2003)foranoverviewofenvironmentalpoliy intheEU.

2

Diretive90/219/EEC dealtwiththe handlingofGMOs inaontaineden-

vironment. It provided that member states draft emergeny plans in ase

of aidents, notify the Commission thereof, et. Next to Diretive 90/220

and Diretive 90/219,the members states had detailed regulationonern-

ingthe importsof GM-seeds,eldtrials, ommerialplanting ofGM-rops,

and ommerialisation of GM food and feed produts. In the end, eah

member held a de fato legal right to ban GM in food and feed based on

nationallegislation.

The next step in regulating the inreasing streamof GMOs wasReg-

ulation258/97 passed on27 January1997 regarding novel foodsand novel

foods ingredients. Its objetive was the regulation of foods resulting from

biotehnology. It stipulates that novel foods are subjet toa safety assess-

ment and the onsumer must be informed that the food ontains a GMO

or is derived from one. The denition implies that a food whih has been

made of a GMO or with the aid of a GMO even when the GMO is not

detetableinthe nalprodut must belabelled. Thisis,for instane,the

ase when the orn plantwas maderesistantagainst aertain pestiideal-

thoughtheresultingourdoesnot ontainany GMOinastritsense. The

safety assessment istobearriedout by nationalbodiesinliaison withthe

European Commissionand is relatively umbersome. The Commission felt

the need tomakesome additionsto 258/97in the Commission Regulation

1813/97, agreed on 19 September 1997. The Regulation laries that the

labelling applies to produts as well that have been on the market prior

to Regulation258/97 entering into fore and states that uniform Commu-

nity labelling rules are needed sine individual member state ations are

inappropriate.

The revision of Regulation 90/220 started shortly after its adaption.

TheCommissionsetforthaproposalforaDiretiveonthedeliberaterelease

of GMOs (Com/1998/85) on 26 November 1997 merely 10 months after

adopting the former. The issue beame so ontested, however, that the

revision did not ome about before 2001. In April 1998, the European

CommissionissuedthelastapprovalsofGMvarietiesinthefaeofagrowing

resistane by member states. A Frenh ourt plaed an injuntion on the

growing and marketing of a GM orn variety in September and Greee

bannedthe importandsaleofGMrapeseed. InMay1999,theEUpanelon

approvals suspended the proess for Pioneer Hi-Bred's GM orn followed

by another blow in June when Frane, Denmark, Italy, Luxembourg and

The Couniladopted Regulation1139/98on26 May 1998 whih ov-

ers the labelling of GM maize and soy varieties that did not fall under

Regulation 258/97. It took a mere three months to pass the Regulation.

The Commissionpassed aRegulation(49/2000) on10January 2000whih

further amended Regulation 1139/98 by speifying that a food may not

ontain more than 1 perent of an ingredient that is genetially modied

or derived from a GMO. The threshold of 1 perent is low and requires

great eort by operators in separating GM materials from non-GM ma-

terials, thus inreasing the prie by around 12 perent (Young 2001, 17).

For instane, Japan and Canada have adopted a threshold of 5 perent

(Carter & Gruere 2003, 3) for GM and non-GM rops transported on the

same truks, for example. Commission Regulation 50/2000 supplemented

49/2000onerning GM additives and GM avourings.

Sienti progress made it neessary to revise Diretive 90/219/ECC

by Diretive 81/98/EC signed on 26 Otober 1998. It simplied the legal

proedures appliabletothe ontaineduse ofGMOs andintroduedafour-

level risksale while speifyingminimum requirements for eahrisk level.

CounilDiretive98/95/ECsoughttoremoveallbarrierstothetrade

ofseedswithintheCommunityandtherebyamendedDiretives66/400/EEC,

66/401/EEC, 66/402/EEC, 66/403/EEC, 69/208/EEC, 70/457/EEC and

70/458/EEC.Itsetoutrulesforthemarketingofgenetiallymodiedplant

varieties and plantgeneti resoures.

Diretive 18/2001 required three readings in the Parliament and the

Counil, and the Parliament found the nal deision only in the Conilia-

tion Commission on 13 Deember 2000 before it was formally adopted on

12Marh2001(Italyand Franeabstained). TheDiretivedeterminesthat

GMOs must be subjeted to an environmentalrisk assessment beforethey

maybeplaedonthe marketand thatGMOs whih areresistanttoantibi-

otisused inmediationsare toberemoved fromthemarketwithinagiven

time. The appliation for an approval of a GMO ishanded in with a om-

petent national body whih srutinises the appliation. If it approves the

appliation,itsubmitsitsverdittoallmemberstateswhihthenhavethe

right to raise objetions within a speied period of time. If any member

state objets to the approval, the appliation is referred to the European

Commission and a `large onsultation' is held. Furthermore, the Diretive

speies traeability, monitoring and labellingrequirements.

Diretive 1830/2003, passed on 22 September 2003, further rened

therulesregarding traeabilityand labellingoffoodandfeedprodutsthat

ontain GMOs, amending Diretive 18/2001. Its stated objetive is toput

in plae a system that allows a swift reall of foods or feed if any risk is

found. The Diretive requires ompanies to keep reords of GM produts

that inludes food and feed for at least ve years and transmit these

reordsatanystage ofthe ommerialhain. Labellingismandatorywhen

DNA or modied protein is inserted into an organism. The law extended

the labelling sheme to produts whih are made of GM ingredients. For

instane, bisuits that ontain maize oil from GM maize must be labelled

with `produed fromgenetially modiedmaize'. Furthermore, labelling is

madeompulsoryforfeedinthe samefashionasforfood. Thethresholdfor

labellingin the presene of adventitious and tehnially unavoidable traes

GM produts is formulated as no higher than 0.9 perent as opposed to

lower than 1 perent, thus lowering the threshold further. The European

Parliament introdued as well a 0.5 perent threshold for produts that

are unauthorised but have reeived a favourable risk assessment from the

European Food Safety Authority. The Diretive allows member states to

takeappropriateationtoensure thatnon-GMrops arenot ontaminated

with GMrops.

Similarly,Diretive1829/2003setupashemeofauthorisation,super-

vision and labelling for food and feed that is not produed `from' a GMO

but `with' a GMO. There is a 0.9 perent threshold for the presene of

adventitious and tehnially unavoidable traes of GM produts and asi-

enti risk evaluationregarding risk tohuman health and the environment

isrequired. CommissionRegulation641/2004(6April2004) lays downthe

detailsof the implementationof the Diretive.

In 2003,the EuropeanParliamentand theCounilpassed Regulation

1946/2003/EC(15 July 2003)that onerns the transboundary movement

of GMOs. The Regulationtransposes parts of the Cartagena Protool on

Bio-safety intoCommunity law by requiring exporters of GMOontaining

oronsisting produts to delarethe presene of GMOs tothe importer.

To perfet the monitoring of GMOs on the market, the Commission

deided that every authorised GMOmust ontain an unique identier, i.e.

an unique DNA or protein sequenes without funtion (Commission Reg-

ulation 65/2004, 14 January 2004). New appliations for approval must

ontain anidentier and the holder ofapprovalsmust developed and regis-

ter auniqueidentier. Theidentierhelps totraeaGMOthroughoutthe

The EU established an elaborate regulatory framework and in May

2004, the European Commission ended the 5-year long moratorium of ap-

provalsby allowing theommerialisation ofSyngenta's Bt 11ornvariety.

The onitdid not end with the deision, however. Some member states

stillresisted GM produtsand some delared that they would use a lause

tokeepGMprodutoutoftheirmarket. InSeptember2004,Greeebanned

the ommerialisation of GM maize seeds and Cyprus mandated that GM

andGM-produtsmustbeshelvedseparatelyinsupermarkets inSeptember

2005, whih the Commission delared violating European law in January

2006.

Tosummarisethetangledmass oflegislation,I reiterate theve most

important points. First, any GM ingredients for food and feed must be

approved by the European Commission and its member states to be om-

merialised withinthe EU. Seond, any foodthat ontains GMingredients

or is made of GMOs must be labelled aordingly exept where the ingre-

dient remains below 0.9 perent for an authorised GM ingredient and 0.5

perent if the ingredient is unauthorised but has reeived a positive safety

assessment. Third, food or feed ontaining GM strains with an unknown

risk are barred from entering the EU. Fourth, meat, eggs and dairy prod-

utsfromanimalsfedwithGMfeedareexemptedfromlabelling. Fifth, any

GMprodutmust betraeable throughoutthe foodhain and theinventor

must provide test proedures for the GM strain. In anutshell, Europeput

GMOs in aorset.

2.3 Over the Atlanti: the US Response

The setion above skethed the ations by the European Union and its

member states. But what did the other side do? The regulatory proess

started to ath up with the development in the US in 1992. After hav-

ing reeived numerous enquiries from industry, government agenies and

onsumers, the Food and Drug Administration issued a poliy statement

on foods derived from new plant varieties. The statement explains that

foods from genetially modied plants are subjet to the same regulatory

framework astraditionalplants. The regulatorystatusof a food,irrespe-

tive of the method by whih it is developed, is dependent on the objetive

harateristis of the food and the intended use of the food 3

. This meant

thatfoodontainingGMOs istreatedde fatoasanyother unlessevidene

ontraditing the safety emerges.

Pzer reeived the approval from the Foodand Drug Administration

to sell the rst bioengineered food ingredient in 1993 and the use of bio-

engineeringinropshas proliferatedrapidlyinthe US,someommentators

alled it the `fastest adoption of a new tehnique in history'. Of the soy-

bean planted inthe USapproximately54were genetially modiedand 25

perent of the orn was genetially modied in 1996 (Dohlmann, Hall &

Somwaru 2002, 108). The US notied the growing unease inEuropeabout

GMOs in food and feed but was not sure whether the septiism towards

GMO was permanent or merely the result of the previous food sandals

and thus quikly forgotten. In the US, onsumers have been unonerned

that their foodontains GMO-rops and the reasonsfor Europe's rejetion

were diult for them to omprehend. When the EU delared its mora-

toriumin 1998, forinstane, ommentators saw aproduer-driven attempt

to protet the European agriultural market. As the Wall Street Journal

(WSJ) headlineniely illustrates: ProtetionismInuenes Refusal toUse

GMFoods (8April2004). Otheranalysts asked Biotehnology: TheNext

TransatlantiTrade War? (Pollak &Shaer 2000).

Farmers started lobbying their Congressmen, and in January 2003, a

groupofCongressmensentalettertotheWhiteHouseasking thepresident

tolaunha formalomplaintat the WTO. Consequently, the presidentin-

reasedthepressureonEuropeandstatedinMay2003thattheUSintended

to hallenge the European moratorium on GMO approvals. He put it into

pratiae and asked the WTO to rule on the EU's moratorium although

the outome was unertain and researhers thought that [...℄ almost any

outome of the disputein the WTO (favouring either the omplainantsor

the plainti) is possible (Matulionyte 2005, 49). The FAO had already

noted in 1997 that there was often insuient sienti and quantitative

evidene for risk assessments and more qualitative rules are likely to be

hallenged under trade agreements (FAO 1997, 4). The WTO eventually

ruled in February 2006 that the EU moratoriumwas illegalbeause it was

not suiently substantiated with sienti evidene that GMOs in food

3

Statement of Poliy: Foods Derived from New Plant Varieties, Federal Register

Vol. 57,No. 104,29/05/1992,p. 1,http://vm.fsan.fda.gov/~lrd/fr92529b.html,

aessed07/11/2006.

or feed pose a risk to humans. At that time, the EU had already liftedits

moratorium,however.

2.4 Redistribution due to Regulation?

RigidEuropean GMO regulation had a de fato protetive nature beause

theEuropeanUnionhas beenlaggingbehindtheUSintermsofadaptation

of GM rops. US farmers planted approximately 54 perent GM soybeans

and 25 perent GM orn in 1996 (Dohlmann, Hall & Somwaru 2002, 108)

while this share inreased to 80 perent for soybeans in 2002 (WSJ, 20

August2002)althoughsomeGMropstookdipsin1999allegedlyduetothe

dispute(Dohlmann,Hall& Somwaru 2002, 109). Inthe meantime,Europe

hasseen notmuhmorethan eldtrials,and thenumberofnotiationsto

the European Commission of eld trails dereased by 78 perent between

1998 and 2001 for `non-tehnialreasons' (Lheureux et al.2003).

Muhinkhasbeen spilledonthedisputeand thereisampleanedotal

evidene that the dispute did indeed aet Transatlanti trade. The WSJ

noted the onnetion between soybean pries and the GMO dispute on 25

July 1997. Figure 2.1 shows a steady derease of the EU's share in US

agriultural ommodity exports in the seond half of the 1990s, and the

authorspointto the dispute asthe ause of this deline(Lin, Chambers &

Harwood (2000, 29); see similarlyCapell (2003)). By 2003, the exports to

Europe had fallen by 50 perent to 1 billion US dollars a year (WSJ, 01

July 2003).

Attheheightofthedisputein2000,there wasonsiderableanxietyin

the marketabout the future of agro-biotehnology,as the quote illustrates:

Despitethe relatively smallmarketshares fornon-biotehorn

and soybeans, demand for non-bioteh ommodities is highly

uidandouldexpandquikly,dependingonwhetheronsumers'

preferenesfornon-biotehfoodprodutsexpand,aswellason-

sumerpreferenesregardingtheuseofbiotehropsinindustrial

usesandinlivestokfeed(Lin,Chambers&Harwood2000,29).

In sum, there is ample desriptive and anedotal evidene that Eu-

rope's rejetionof GMOs indued onsiderable unertainty ininternational

marketsaboutfuturesharesofGMOandnon-GMOrops. Theworrieswere

Figure 2.1 EUShare of US Cornand Soybeans Exports

Soure: Lin,Chambers & Harwood (2000,30)

to Europe's GMO regulation. However, sholars have largely ignored the

responseofommodityderivativemarkets,espeiallyoutsidethe US,whih

the literature review in the next haptershows.

Literature Review

This study builds on the literature of the politial eonomy of nanial

markets. The elds the study relates to are manifold and the literature

review must stik to astrit priority list. I start by reviewingsome studies

onhownanialmarkets,inpartiular,ommoditymarkets,reattoonit

and ooperation in the international realm. Finanial markets have been

used toshowredistributiveeets of politial events forwhihI surveythe

ndings. Then I ite some studies whih use nanial markets to study

the eets of regulatory deisions. Several studies srutinise the eets

of events around GMOs in food and feed, many using nanial markets

but not exlusively. The literature review reveals that there is a lak of

politial eonomy studies on the dispute between the EU and the US over

genetiallymodiedorganismsinfoodandfeedwhihhasbeennotedbefore

byYoung: [...℄ whilepolitisareverymuhinevideneinthetransatlanti

dispute onerning agriultural biotehnology, politial siene has largely

been absent (Young 2001, 3).

There are several studies how nanial markets reat to onit and

ooperation ininternational politis. Crowley & Lovisek (2002) evaluates

whether 36 events of politial unrest in South Amerianountries between

1991and1999hadanimpatonexhangeratesandndsripplesuptothree

months after the event. Esalating the event, Shneider & Tröger (2006)

analyse the impat of the rst gulf war and the Palestine-Israel onit

on stok market indies and nd that onitive events sare investors in

major Western tradingpits away fromstoks althoughonitiveeventsat

the binningof the FirstGulfWarliftedthe DowJones Index,onrming a

`war rally'. The stok pries of defene rms are sensitive to international

onit aswell (Capelle-Blanard& Couder 2006). Chen & Siems (2004)

employthesameseveritybyanalysingterroristattaksdatingbakto1915,

the Iraqi invasionof Kuwait and the 9/11 attaks.

Studiesontheinueneofinternationalpolitialeventsonommodity

markets andommodityderivate markets arerare. Messmer(2006)showed

thatonitiveresultsdoindeedstirup oilspotpriesalthoughGuidolin&

Ferrara(2005)ndthat theonsetof onitsdereases oilfuturesprobably

takingoutpriorspeulativepressure. Theyalsondthatommodityindies

experiened a drop aswellwhihthey interpretas anend tohoarding.

Finanial markets have been usedtoshowthe redistributiveeets of

politial deisions and politial events suh as the passing of legislationor

eletions. Behtel (2006, 2) divides the literature on politial events and

nanialmarkets in four broad ategories. First, a strand analyses the re-

distributive eet of partisan politis. Seond, sholars are interested in

eletionyle eets whileathird eldfousesonhow institutionalhara-

teristis aets nanial markets. Fourth, a strand fouses onthe eet of

single politial events onnanialmarkets.

The inuene ofpartisanpolitis ondistributionhas been studiedvia

nanial markets. The eletoral information hypothesis states that, rst,

dierentpolitialpartiesadoptdistintmaroeonomipoliiesandthusin-

uene protseitherdiretly orindiretlythrough ahangeof the ination

rate, ruial for the real return of an investment. Seond, forward looking

investors inorporate this informationinto pries and update them upon a

hangeinthelikelihoodofapartisanhangeingovernment(Freeman,Hays

& Stix 2000). The hypothesis has been developed for bond markets show-

ingthat eonomi equilibriafollowsmoothlypolitialequilibria ontingent

on the institutional framework of maroeonomi poliy. Where entral

banks are independent, the eets are less pronouned than in ountries

with bound entral banks (Freeman, Hays & Stix (2000); f. also Ruo

(2005)).

The eletoralinformationhypothesis has been appliedto equity mar-

ketsaswell.. Vuhelen(2003)showsthatthepartisanhangeofgovernment

inBelgiumfromlefttorighthadapositiveimpattheBelgiumstokindex

and Herron(2000) supports the partisanhypothesis,too, forthe 1992 ele-

tioninGreatBritian. MGillivray(2003)estimatesthe redistributiveeet

of the government hange between ertain setors. She interats this out-

ome with politial institutions. A proportional eletoral formula should

inrease the number of veto points that ought to be ompensated. She

expets therefore the eet to show up later whih her study onrms in

a sample of 14 OECD ountries between 1973 and 1996. Herron, Lavin,

Donald &Silver(1999)showthat markets expet favours of apresident for

the setor he publially supported in the run up to the Presidential ele-

tion in the US in 1992. They regress the setor indies on the likelihood

ofthe respetive andidatebeomingpresident andnd that the likelihood

inuenes the performane of the setor index. Thus, markets antiipate

post-eletion redistribution among setors. They rejet, however, the par-

tisan hypothesis. The market as a whole did not move along with the

likelihood that BillClinton, a demorat, beame President. In sum, mar-

kets inorporate expetations about distributive measures by governments

both between setors and between labour and apitalintopries.

Politialinstitutions regulate the funtioningof markets and thusin-

uene howonsumer and produers rents are distributed in the eonomy,

e.g. by prohibiting monopolies. A hange to the institutional system or

the laws governing the market an hange this distribution. Changes in

the taxode andregulationand deisionspreventing monopolieshavebeen

subjeted toeventstudiestherefore. Cutler(1988)failtondthe predited

redistribute eet among produers of a hange in apital taxes in the US

while Sinai & Gyourko (2004) laim that the Taxpayer Relief At aeted

ompanies'stok priessigniantlywhenitwas passedin1997and Carow

&Heron(2002)ndtheirexpetationsregardingtheredistributiveeetsof

theFinanialServiesModernizationAt(1999)reetedinthestokpries

oftherespetivenanialsetor. Theredutioninapitalgainstaxin1997

in the US should have inreased the value of stoks bears out empirially

(Lang & Shakelford 2000). Rose (1985, 314-15) takes the example of the

deregulationampaign of the InterstateCommere Commission inthe late

1970stostudy oligopolyrents. Shends thatderegulationtooko roughly

31perentofexpetedprotsastoldbythe motorarrierindustry'sstoks.

Other studies onrming the eet of regulatory events on nanial assets

are Kalbhenn (2006), Brady & Feinberg (2000), and Boardman, Vertinsky

&Whistler (1997).

Thereareseveralstudiesontheeet offoodsafetynewsonommod-

ityfutureswhihisrelatedtomystudybeausethedisputehas beendriven

mainlyby foodsafety onerns. MKenzie &Thomsen (2001) evaluatethe

eetsof meatreallsdue tothe ourreneof E. Coli O157:H7,aoliba-

terium,on beef future pries. They nd signiantnegative returnsdue to

the announements do not seem to have an eet on live attle or boxed

beef. They state that their nding is inline with other researh indiating

thatfoodsafety onernsdonotseem tohaveanimmediateshort-termim-

pat on the wholesale or farmer level. Lusk & Shroeder (2002) study the

eet of meat realls onliveattle and lean hog futures pries and rejet a

short-term eet as well. These results do not ome as a surprise beause

studies on the demand and onsumption of meat and food safety reports

nd the impat negligible(Piggott& Marsh 2004).

Another study on a major food sare is Henson & Mazzohi (2002)

albeitonequitypriesnotommodityprie. Theyanalysetheimpatofthe

Britishgovernments'announement that Bovine SpongiformEnephalopa-

thy (BSE) poses a potential risk to human health. The study uses equity

pries of various rms and setors. Using various estimation tehniques

they nd that the announement had a signiant negative impat in the

beef,petfood,animalfeed, anddairysetorsand apositiveonothermeats

setors(infat,the eet on24ompanies' stok prieswastested individ-

ually).

The StarLink episode provides a good ase for studying the eet

of market signals related to GMOs on nanial markets. StarLink is a

genetiallymodiedornvariety byAventiswhihwasonlyapproved asan

animalfodder,butnotforhumanonsumptionbeausetherewereonerns

thatitouldause allergireationsinhumans. Nevertheless, the StarLink

orn found its way into the food hain. Friends of the Earth found traes

of StarLink orn in tao bells whih the Washington Post reported on 18

September2000. Promptedbythisreportnumerousotherfoodsweretested

andrealledwhentraeswere found. Golub,Wilson&Featherstone(2004)

analyse the eet these realls had on Kraft Food's and Kellogg's' stok

pries aswell as ConAgra's announement that it would lose itsorn mill

beause it ould not rule that it had reeived ontaminated orn. They do

not nd any reations of theirstok pries tothese events, though.

Carter & Smith (2004) use the relative prie of a substitute (RPS)

method to evaluate the impat of the StarLink episode. It builds on the

foreast of a oningration model, here orn and sorghum, both onsidered

substitutes. They nd that the StarLink ontamination lowered US orn

pries by about 6.8 perent for atleast a year (Carter& Smith 2004,2).

Parell & Kalaitzandonakes study the reation of soybean futures

thedependent variableofthis study, tootoannounementsof majorfood

retailers to ban bioengineered rops from their produts. They use daily

data from the Chiago Board of Trade (CBOT) on the pries hanges of

soybean futures ofthe periodJanuary1995 throughDeember 2000aswell

as soybean futures from the Tokyo Grain Exhange (TGE) for the period

May 2000 to Deember 2001, whih are GMO-free. They test eight ban

announements mostly from European retailers and some others outside

Europe, though it remains unlear whih preisely. They do not nd any

eet eitheronthe CBOT nor onthe TGEsoybean futures priesnor does

thepremiumofGMtonon-GMsoybean futuresattheTGEhangehange

notieably. Their onlusion is that the markets did not interpret the ban

announementsas indiators for aonsiderable demand shift towards GM-

free rops. However, as they admit, soybeans are mainly used as animal

feed, so the food retailer's ban announements were not really relevant to

thesoybean market. Non-politialeventsdidnot seemtohavestirredom-

modity markets.

In a previous study, Parell & Kalaitzandonakes (2001) estimate the

impatofthe levelofmediaoverageofseveralinternationalnewspaperson

biotehnology and 200 reall/ban announements on orn futures fromthe

CBOT for the period 1990 to 2000. They nd no eet of the newspaper

overageandonludethattheshareofnon-transgeniornissmallrelative

totransgeniorn. Thelevelvariable,however, annotapturewhetherthe

news was bad or simply a fatual report. Surprsingly, they nd ban/reall

announementsto have a positive impaton pries.

Dohlmann, Hall & Somwaru (2002) ondut an event study linking

the prie of seed ompanies to events relevant to the biotehnology setor.

They selet 13 events and ve seed ompanies for the year 1998 and 19

events and fourseed ompanies forthe year 1999. They divide theirevents

intothreeategories,namely`regulatoryations';`rophandler',`proessors

and retailerannounements'as wellas `environment,health orlegal news'.

Regulatoryeventshadthestrongestnegativeimpatonbiotehnologyrms'

stok prie in fat, all their events are ontra-biotehnology and they do

not sample `goodnews'.

Tosummarise,thereare someeventstudiesonthe eetsofeventsre-

latedtoGMOinfoodandfeed. However, hardlyanystudy expliitlystates

as a framework redistribution while studying the onit over GMOs. As

aresult, the literature has two shortomings froma politial eonomy per-

spetive,namelyafousontheNorthAmerianmarketandonnon-politial

ommoditiesontheUSmarketduetoaontimationwithGMornandPar-

ell& Kalaitzandonakes's (2004) attempt to show a hange in the relative

prieofGMandnon-GMattheTokyoGrainExhange. Thenotableexep-

tion of ananlysis of politial events isDohlmann, Hall& Somwaru (2002).

Their sample of politial events is, however, very limited. What is laking

is a omprehensive analysis of the politial signals regarding the prospets

of GM rops. Seond, there is little knowledge on the reation of nanial

markets other than the US'. This is surprising as the desriptive evidene

given in Setion 2.4 suggests that there must have been beneiaries from

Europe's market losureto GM rops. Brazil and the EU hardly grew any

GMrops and shouldhave beneted froma GMban, yet theiragriultural

ommodity markets lak any researh. This study is an attempt to lose

this gap. Seond, from a politial eonomy perspetive I fous on politial

events inthe expliit searh for redistributionof inome through politis.

Theory

The objetiveof this hapter isdevelop hypotheses evaluatinghow the po-

litialdispute between the EU and the US impated derivative markets of

agriultural ommodities. In the beginning, I sketh the theory of futures

priinginSetion4.1fortworeasons. First,abasiunderstandingoffutures

priing is neessary to understand how futures pries reet the expeted

eet of regulationonsupply and demand of theunderlyingasset and thus

how politial events show up in futures pries. Seond, the theory of fu-

tures pries mandates several ontrol variables in a time series regression.

Then,I explaininSetion4.2the assumptionofsemi-strong eientnan-

ialmarkets neessary forthe eventstudy approahto bevalid. I expound

the theoretialmodelhowtradersininternationalagriultural ommodity

markets reat to the dispute between the EU and US into in Setion 4.3.

In the end, I derive the hypotheses tobe tested.

4.1 Theory of Futures Priing

The aim of this researh projet is to demonstrate redistributive eets

of politis. I use agriultural ommodity futures for doing so. Therefore,

a basi understanding of agriultural ommodity futures is a prerequisite.

Futuresarebasedonforwardsandbelongtotheseuritylassofderivatives.

A derivativeis aninstrumentwhose value depends onthe value of another

asset, the `underlying' asset. I start o by introduing the mehanis of

forwardsand futuresandthengoontothetheoriesoffuturespriingwhih

willgive anindiationas towhihontrolvariablesare neessary ina time

series analysis.

Forwards Aforward ontratisanagreementbetween twopartiesabout

the future transation of an asset and a orresponding payment in the fu-

ture. There are always two sides to a forward ontrat and the sum of all

outstandingforward ontratsiszero. In otherwords, toevery person hav-

ingthe right to buyan asset inthe future, there isa person obliged tosell

the asset.

Futures Themaindierenebetweenaforwardandafuturesisthetrans-

ation of gains and losses due to the divergene of the spot prie and the

ontrat prie (Grinblatt& Titman 2001, 219). Prots and losses ina for-

ward arerealisedonthe deliverydate. Forinstane, someonewhoboughta

forwardataprieabovethespotprieonthedeliverydaymakesaloss;one

ould have bought the asset heaper in the spot market. The total prot

(loss) is the spot prie on the delivery day minus the futures prie agreed

in the ontrat

S _T − F ₀

a futures, however, the prots (losses) aumulate every day between the

ontrat making and maturity. It is

F 1 − F 0

pries ondate 1

F ₂ − F ₁

and soforth untilmaturity whenever

F T −1 − F T −2

T − 1

S t − F T −1

In all, the prot (loss) equals the spot prie at delivery minus the futures

prie

S T − F 0

made on a forward ontrat but the timing of the ash ow diers. Due

to the re-settling of the ontrat prie every evening, futures are less risky

(Hull2003).

Beause futuresaretradable, theontratspeiationsare standard-

ised. Usually, the exhange speies suh things as delivery date and for

ommodities delivery loation,qualityand quantity. Next to ommodities,

derivativesare widely traded for U.S.treasury bond futures with long ma-

turities, Eurodollar futures onthe LIBOR inthree months time, and S&P

500futures onfutureleveloftheS&P 500indexand theleadingurrenies.

The value of futures is set to zero every evening sine the ontrat

forwards wheretheontratprie isrewritteneveryday whilethe maturity

dateremainsonstant. Beause thefutures ontratis rewritteneveryday,

thefutures prieisequaltothespotonthe deliverydate. Forexample,the

futuresprieof asoybean deliveryinMay isequaltothe spotprieinMay.

Theories offuturespriinglinkthe spotprieof theunderlyingasset tothe

futures prie.

4.1.1 Cost-of-Carry Model

The ost-of-arry models links the spotprie tofutures prie based onthe

onept of arbitrage. Arbitrage in the strit sense is a trade to generate

a risk-free prot without investment (Kolb & Overdahl 2005, 106). The

ost-of-arrymodelpreditsthatthefuturesprieequalsthespotprieplus

theostofarryingtheunderlyingassetintothefuture. Thereshouldbeno

arbitrageopportunity between buyinganassetinthespotmarket, sellinga

futuresandarryingtheassetintofuture. Carryingtheassetintothefutures

entails some ost, the ost-of-arry whih is also alled arrying harge.

Carrying harges enompass storage osts, insurane osts, transportation

osts and naning osts and an vary widely between assets. Let me set

out the onept with aview onagriultural ommodities.

Cash-and-Carry Arbitrage Let us onsider what is alled Cash-and-

Carry Arbitrage. An arbitrageur ould buy an asset in the spot market

at time

t = 0

ontrat for the asset. If the futures prie is higher than the loan plus

interest, whih the arbitrageur an easily ompute, he will make a prot

upon delivery of the futures ontrat. In order to prevent arbitrage, the

futures priemust be less thanorequaltothe spot prieof the ommodity

plus the arrying harge. Formallythis is:

F 0,t ≤ S 0 (1 + C)

where

F 0,t

t = 0

t

S 0

spot prie at time

t = 0

C

of the spot prie.

Reverse Cash-and-Carry Arbitrage Therearises an arbitrage oppor-

tunity ifthe spotprieplusthe ost-of-arryexeedsthe futuresprie. The

arbitrage strategy would beas follows: Sell the asset inthe spot short and

loan the proeeds while buying futures at the same time. At the delivery

date, the arbitrageur gains the proeeds of the loan and would repay the

short-sold asset with the deliveryof the futures whih would bea risk-free

strategy. Thereforethespotprieplustheostofarryshouldnotbehigher

than the futures prie. Expressing this mathematially,wehave:

F 0,t ≥ S 0 (1 + C)

Combining Equations4.1 and 4.2we derive:

F 0,t = S 0 (1 + C)

In the same fashion one an dedue that the prie of futures with a

shorter maturity should equal the prie of futures with a longer maturity

plus the ost of arry. Notethat these resultsare basedon the assumption

of perfet markets, i.e. there are no transation osts and there is free

ontrating. There are, however, hardly any truly perfet markets and

several fators inuene the ost of arry

C

Let us now venture to imperfet markets and analyse how agriul-

turalommodityfuturesould possibly bepried. Generally,thereare four

soures of imperfetion to markets: diret transation osts, unequal bor-

rowing and lending rates, margins and restritions on short selling, and

limitationstostorage. In evaluatingthe priing of agriultural ommodity

futures, storability isa ritial issue. Only ommodities that an be stored

an be arried into the future and thus serve as the underlying asset to a

futures. Impairedstorabilitysets limitstothepossibilityofarbitrage. Gold

isperhapsthe mostdurablegooditsimpliedreporate isverylose tothe

atualreporate (Kolb&Overdahl2005,124)and fresheggs areprobably

one ofleast durablegoodsforwhihafutures existed (atthe ChiagoMer-

antile Exhange). There are several reasons why agriultural ommodity

markets are imperfet: short selling is diult, the prodution is seasonal

and the storability is limited. Another reason why the agriultural om-

modity futures markets are imperfet isa onveniene yield.

Agriulturalommoditiesouldhaveaonveniene yieldtofoodman-

ufaturers. Convenieneyieldmeansthattheholderderivesautilityjustby

holding the ommodity, therefore alsonamed storage model. For example,

a manufaturer buys a vital input well in advane before atually needing

itbeausethe whole produtionwould grind to ahalt if that input misses.

Thenthespotprieexeedsthefuturesprieandthenearbyfuturesexeeds

the distant futures and the marketis in bakwardation. The opposite to a

market in bakwardation is a market in ontango, i.e. nearby futures are

below distant futures. Note that bakwardationis distintto the theory of

normalbakwardation whih I disuss next.

4.1.2 Theory of Normal Bakwardation

The theory of normal bakwardation predits the spot and futures prie

relationbythedierentbehaviourofmarketpartiipants. AboveIdisussed

why futures pries an deviate from the spot prie. So one ould suppose

that futures pries should at least equal the expeted spotprie due tothe

law of arbitrage. However, there are limitstoarbitrage and not everybody

in the market isa speulator. There are roughly two groupsin the futures

market: speulators and hedgers who have dierent attitudes to risk.

Hedgers use the futures markettoreduetheirexposuretospotprie

utuations. Afarmerould,forinstane, sellthe entire(expeted)harvest

uponplanting. Hedoesnotriskahievingapriebelowhisprodutionosts

althoughhe mightforgoa prot if the spotprie inthe future is abovethe

futures prie. Hedgers sellfutures, they are `shorta futures'.

The seondgroup inthe marketare speulators and they should buy

futures and bear the risk that the spotprie is the below the futures prie

andtheypaytoomuhfortheommodityonthedeliverydate. Speulators

donot atuallyneedtheommoditysowhyshouldthey enterthe ontrat?

(Indeed,most futuresare `losedout'beforedeliverymeaninga traderwho

sold a futures buys one.) Speulators trade, of ourse, for a prot whih

they reapbyenteringonlythoseontratsthatarebelowthe expetedspot

prie. Although expeted future prie are not preditable they should be

on average, losses and gains average out in the long run and speulators

expet aprotbasedonthe distributionof expetedfuturepriesthe mean

beingabovethe futuresprie. Therefore, thefutures prieandivergefrom

theexpetedspotprie. The extentof thedivergenebetweenfutures prie

and expeted spot prie depends on the risk aversion urves of the hedgers

and the speulators and whether hedgers want to be net long or net short.

Thistheory wasdevelopedbyKeynes(1930)and Hiks (1950)andisalled

thetheoryof normalbakwardation. Aordingtothetheory futurespries

shouldrise overtheir lifetime 1

. In their view, hedgers are net short futures

and speulators are net long futures. Hene, futures pries should rise as

they approah maturity and require the researher to ontrol for this in a

statistialanalysis.

4.1.3 Capital Asset Priing Model

The CapitalAsset Priing Model(CAPM) is ageneraltheory how toprie

assets and has been applied to futures as well. The CAPM shows that the

variane of the returns of an asset is unimportant for the expeted return.

What is important is the ovariane of an asset's returns with the market

return,saled by the variane ofthe marketreturns. The ovariane ofthe

asset'sreturnswiththemarketisthesystematirisk,soeven diversiation

annoteradiatethis risk. Onlythesystematiriskshouldbeompensated

beause unsystemati riskisavoidable through diversiation. The CAPM

modelis

E(R j ) = r + β j [E(R m ) − r]

where

r

E(R j )

j

E(R m )

β j

of asset

j

β

to what a degree the asset moves `along with the market'.

β

estimated froma regression suh asthe following:

r j,t = α j + β j r m,t + ε j,t

where

r j,t

j

t

r m,t

onthe marketinthe

t

α j

ε j,t

for day

t

β = 1

the marketportfolio. The asset should then earn the return of the market

portfolio. A

β = 0

the risk-freerate of interest.

Empirial evidene on the CAPM as well as the theory of normal

bakwardation for futures markets is mixed. Both theories nd approxi-

1

Empirially, futures priesand spot priesdonot alwaysonvergein themonth of

maturity(Rausser&Carter1983,474).

matelyequal numbers ofsupportandoppositionin empirialstudies(Kolb

&Overdahl2005, 134).

Conlusion The objet of this setion has been to show how the eets

regulation may ultimately show up in futures pries . I skethed the me-

hanis of futures priestoshow howfutures link the expeted prie ofthe

underlyingassettoananialassetbeauseanalysingfuturesisfairlynovel

inthe politial eonomy of nanialmarkets; other asset lasses are better

known.

Seond, theoretial onsiderations ited above mandate the following

ontrovariablesin a time series analysis. First, a variable for the time-to-

maturityeetbothinthemeanfuntionaswellasinthevarianefuntion.

Seond, a variable for the seasonaleet in the variane funtion, but not

in the mean funtion beause it should be independent of seasonal eets

(Blak 1976a). The exat speiation is disussed in due ourse (Setion

5.5.3 ontime series speiation).

4.2 An Assumption: Eient Finanial Mar-

kets

Thereare twomain strandsof theory innane: First, the eientmarket

hypothesisputforwardbyFama(1965)andseond`behaviouralnane'. In

ordertobevalid, thisstudyassumessemi-strongeieny innanialmar-

kets. This setion skethes the foundationof the eient market hypothe-

sisandbriey statesthe argumentsagainstthe eient-markethypothesis,

omingin the formof behavioural nane. This setion, however, doesnot

survey the state of the disussion on market eieny versus behavioural

nane sine the thesis uses the semi-strong eieny as an assumption

standard in event studies and I have no desire to ontribute diretly to

this ontroversy.

4.2.1 Eient Market Hypothesis

Eieny with regard to nanial markets usually refers to informational

eieny. `Informationally eient' means that pries reet all available

andrelevantinformation. Thinkablearealsooperationally eientnanial

markets, i.e. the tradeisondutedeiently andreliably,oralloationally

eient, i.e. money goes to the most produtive investments (Howells &

Bain2005). `Eieny' refers hereinafter to informationaleieny.

Theeientmarketshypothesis(EMH)hasthreefoundations(Shleifer

2000):

1. Traders are rational,

2. trades of irrational traders are unsystemati and thus anel out in

the mean,

3. where irrational traders at systematially, rational traders will take

advantageofthisthrougharbitrageandthusdrivetheirrationaltraders

out of the market.

There are three forms ofthe EMH aording toFama (1970):

1. Theweakformstatesthatallinformationofthepastisinorporated

into the prie. Past movements of the prie donot allow preditions

of prie movementin the future.

2. The semi-strong form states that all publi information is inor-

porated, meaning that information on the order book or turn-over

renders no superior preditions.

3. The strong form postulatesthat allpubli and all private informa-

tion is reeted by the prie. This means that even insider trading

doesnot rendersustained exess returns.

Tests for the semi-strong form are studies of the impat of (the an-

nounementof)publiinformationonassetpries. Earningannounements,

stok splitsannounementsorseondary oeringsare suhexamples. None

of the tests are nal, yet the hope is that the quantity of supportive stud-

ies `establishes' the hypothesis of semi-strong eient nanial markets

(Fama 1970,404).

The strong form says that there are no individuals with monopolis-

ti aess to information. In favour of this hypothesis is the nding that

most funds are unable to outperform the market over more than a ouple

ofyears; put dierently: individualsare rarelybetteratgathering informa-

tion without others notiing (Malkiel 2003, 60). However, most evidene

suggests that insider knowledge provides an edge over others. Although