PNAS – Proceedings of the National Academy of Sciences of the United States of America
http://www.pnas.org/content/early/
(Accessed 7 November 2015)

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Accurate market price formation model with both supply-demand and trend-following for global food prices providing policy recommendations
Marco Lagi, Yavni Bar-Yam, Karla Z. Bertrand, and Yaneer Bar-Yam
PNAS 2015 ; published ahead of print October 26, 2015, doi:10.1073/pnas.1413108112
Significance
Recent increases in food prices are linked to widespread hunger and social unrest. The causes of high food prices have been debated. Here we rule out explanations that are not consistent with the data and construct a dynamic model of food prices using two factors determined to have the largest impact: corn-to-ethanol conversion and investor speculation. We overcome limitations of equilibrium theories that are unable to quantify the impact of speculation by using a dynamic model of trend following. The model accurately fits the data. Ethanol conversion results in a smooth price increase, whereas speculation results in bubbles and crashes. These findings significantly inform the discussion about food prices and market equilibrium and have immediate policy implications.
Abstract
Recent increases in basic food prices are severely affecting vulnerable populations worldwide. Proposed causes such as shortages of grain due to adverse weather, increasing meat consumption in China and India, conversion of corn to ethanol in the United States, and investor speculation on commodity markets lead to widely differing implications for policy. A lack of clarity about which factors are responsible reinforces policy inaction. Here, for the first time to our knowledge, we construct a dynamic model that quantitatively agrees with food prices. The results show that the dominant causes of price increases are investor speculation and ethanol conversion. Models that just treat supply and demand are not consistent with the actual price dynamics. The two sharp peaks in 2007/2008 and 2010/2011 are specifically due to investor speculation, whereas an underlying upward trend is due to increasing demand from ethanol conversion. The model includes investor trend following as well as shifting between commodities, equities, and bonds to take advantage of increased expected returns. Claims that speculators cannot influence grain prices are shown to be invalid by direct analysis of price-setting practices of granaries. Both causes of price increase, speculative investment and ethanol conversion, are promoted by recent regulatory changes—deregulation of the commodity markets, and policies promoting the conversion of corn to ethanol. Rapid action is needed to reduce the impacts of the price increases on global hunger.