Portfolio theory and market efficiency : an application to marketing strategies of wheat producers

Abstract

In this study portfolio theory is used within the framework of an efficient market to determine the optimal marketing strategy for a representative wheat producer objective is to maximize expected utility. The problem is stated in a control theory framework which is useful for expressing the temporal features of the problem in terms of the need to allow for sequential decisions through a finite time period. The Efficient Market Hypothesis is reviewed including an analysis of the martingale model used to specify the hypothesis, i.e. mathematically quantify. The martingale model is shown to be consistent with the following three attributes. (1) Successive price changes tend to be in the same direction; (2) successive price changes are statistically dependent, and (3) successive price changes generate a non-random series, i.e., serial dependency. It is also pointed out that the Efficient Market Hypothesis is a relative concept and is not independent of the market participant. The expected utility maximizing strategy is developed for a representative wheat producer where the only decision parameter is the optimal level of spot sales over series of decision points. The optimal marketing strategy, assuming market efficiency, results in a sequential allocation of spot sales over the planning horizon with the planning horizon being one year in length and coinciding with the marketing year, i.e., June-June. The relative share of the initial endowment sold at each decision point is indeterminate in general and thus will vary between decision makers. The underlying reasons for this statement are due to differing expectations concerning "net" price changes and the non-homogeneity of preferences. The expected seasonal price change adjusted for holding and storage cost equals the expected net price change. A review of the literature with respect to market efficient in the commodity market is presented to substantiate the assumption that the wheat market is efficient. ...