North American Softwood Lumber

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North American Softwood Lumber Market
Integration Efficiency of Spatial
Arbitrage Fiona Yang, Shashi Kant, Chander
Shahi Faculty of Forestry University of Toronto
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Outline

• Objective of the study
• Limitations of the conventional approaches to
  testing softwood lumber market integration
• Previous studies using PBM
• Parity Bounds Model (PBM) specification and
  estimating procedure
• Application of PBM to softwood lumber market
  integration and efficiency of arbitrage analysis
• Data description
• Policy implication of PBM results for softwood
  lumber

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Objective

• The objective of this paper is to apply a spatial
  price analysis approach - parity bounds model
  (PBM) to test
• softwood lumber market integration between the
  Canadian and the U.S. markets
• Efficiency of spatial arbitrage of softwood
  lumber exports from Canada to the U.S.
• to analyze the effect of trade policy change on
  softwood lumber market performance

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Limitations of the conventional Approaches

• Johansen multivariate co-integration test
• Vector Autoregressive (VAR) model
• long-run equilibrium relationship
• Limitations of the Johansen co-integration
  approach
• ignores the pivotal role played by the
  transaction costs
• unrealistic assumptions about trading behavior
• long-run market equilibrium does not provide
  evidence on the market efficiency

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Previous Studies Using Parity Bounds Model

• Park et al. (2002) - analyzed the effects of
  market reforms on spatial market efficiency in
  different periods.
• Barrett and Li (2002) introduces an extension of
  the standard PBM incorporating trade flow data.
• Padilla-Bernal and Thilmany (2003) applied the
  extended PBM to examine fresh tomato price
  relationships between two major North American
  shipping points and several major terminal
  markets in the U.S. and Mexico.
• Negassa et al. (2004) developed and applied an
  extended PBM to analyze the effect of grain
  marketing policy changes on spatial efficiency of
  maize and wheat markets in Ethiopia.

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Parity Bounds Model Specification

• Parity Bounds Model (PBM)
• Uses both price and transfer costs data
• Relaxes the unrealistic assumptions
• Based on maximum likelihood estimation of a
  mixture distribution model
• Three trade regimes
• Regime 1 at the parity bounds (the inter-market
  price differentials equal transfer costs)
• Regime 2 inside the parity bounds (the
  inter-market price differentials are less than
  transfer costs)
• Regime 3 outside the parity bounds (inter-market
  price differentials exceed transfer costs)

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Parity Bounds Model Specification
Regime 3
Regime 1
Regime 2
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Parity Bounds Model Specification

• Put mathematically
• Let Pti denote the price in market i for the
  period t
• Ptj denote the price in market j for the period
  t
• Tt denote the transfer cost between i and j at t

Regime 1 Ptj - Pti Tt eti with
probability ?1 Regime 2 Ptj - Pti Tt eti -
ut with probability ?2 Regime 3 Ptj - Pti Tt
eti vt with probability 1- ?1 - ?2
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Parity Bounds Model Specification

• The likelihood function for the PBM

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Parity Bounds Model Testing Procedure

• To obtain the probability estimates for the three
  regimes
• Log likelihood Function lnL
• Maximized with respective to ?1, ?2, ?e, ?u and
  ?v
• Using Davidson-Fletcher-Powell algorithm (DFP).
• To test market integration
• null hypothesis ?1 ?2 1
• alternative ?1 ?2 lt 1
• 1- ?1 - ?2
• - frequency of violation of spatial arbitrage
  conditions
• - an index of market inefficiency

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Application of PBM to softwood lumber market
analysis

• Can be used to test the efficiency of spatial
  arbitrage
• Canadian softwood lumber exports to the U.S.
  markets
• Interregional trade within Canada
• Interregional trade within U.S.
• Market pairs
• BC coast the U.S. Atlantic N.E.
• U.S. west coast the U.S. Atlantic N.E.
• For two periods
• SLA April 1996 March 2001
• Post SLA April 2001 Dec. 2004

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Data description

• Price data
• BC coast the U.S. Atlantic N.E.
• Douglas Fir (2x4, StdBtr) FOB mill prices in BC
  coast
• Douglas Fir (2x4, StdBtr) delivered prices in
  the U.S. Atlantic N.E.
• Douglas Fir (2x10, 2Btr) FOB mill prices in BC
  coast
• Douglas Fir (2x10, 2Btr) delivered prices in
  the U.S. Atlantic N.E.
• (Data source Madison)
• The U.S. west coast the U.S. Atlantic N.E.
• Douglas Fir (2x4, StdBtr) FOB mill prices in
  Portland, U.S.
• Douglas Fir (2x4, StdBtr) delivered prices in
  the U.S. Atlantic N.E.
• Douglas Fir (2x10, 2Btr) FOB mill prices in
  Portland, U.S.
• Douglas Fir (2x10, 2Btr) delivered prices in
  the U.S. Atlantic N.E.
• (Data source Random Lengths Yearbooks)

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Data description

• FOB mill prices
• Duty is included in the FOB mill prices in BC
  coast
• Duty rate in different periods
• During SLA, there is no duty.
• April 1, 2001 May 22, 2002, no duty.
• May 23, 2002 Dec. 2004, 27.2 CVD and ADD.
• Delivered prices quoted by the producers to
  their customers on a delivered basis
• Price Differential between delivered price and
  FOB mill price should reflect the freight rate
  between the shipping point and the terminal
  market.

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Shipment of softwood lumber

• Methods of shipment
• rail cars cheaper
• marine when rail car is not available, more
  expensive
• Transportation cost data
• not publicly available
• Reponses of various agencies in the transaction
• Producers we dont have the data
• Wholesalers you should contact the
  transportation companies
• Transportation companies unable to share any
  information
• Government sources no data collected

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Policy implications of PBM for softwood lumber

• Once we get the transportation cost data, we will
  be able to use the PBM to test the integration of
  the market pairs and efficiency of arbitrage by
  estimating the probabilities of the three
  regimes.
• If the probability of efficient arbitrage is
  high, it implies high frequency of market
  integration.
• High 1- ?1 - ?2 indicates high frequency of
  violation of market integration and inefficiency
  of spatial arbitrage.
• Compare the probabilities obtained from different
  periods to analyze the effects of trade policy
  change on market performance.

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Thank you for your attention!