Agricultural & Applied Economics Association

Market Integration, Efficiency of Arbitrage, and Imperfect Competition: Methodology

and Application to U.S. Celery
Author(s): Richard J. Sexton, Catherine L. Kling and Hoy F. Carman
Source: American Journal of Agricultural Economics, Vol. 73, No. 3 (Aug., 1991), pp. 568-
580
Published by: Oxford University Press on behalf of the Agricultural & Applied Economics
Association
Stable URL: https://www.jstor.org/stable/1242810
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 Market Integration, Efficiency
of Arbitrage, and Imperfect
Competition: Methodology and
Application to U.S. Celery
Richard J. Sexton, Catherine L. Kling, and Hoy F. Carman

This paper develops and applies a methodology to test for efficiency of interregional
commodity arbitrage. Application of the methodology requires only time-series data on
prices for alternative cities, regions, countries, or product forms. Yet, the approach is
capable of generating evidence on a number of market parameters including market
integration, arbitrage efficiency, the magnitude of marketing margins, product
substitutability, and competitiveness of markets. Estimation is based on a switching
regression model with three regimes: efficient arbitrage, relative shortage, and relative
glut. Results from application of the model to U.S. celery marketing indicated
significant departures from efficient arbitrage for both California and Florida celery.

Key words: arbitrage, celery, imperfect competition, law of one price, market
integration, price efficiency.

The nature of markets and their role in price de- An application to U.S. fresh celery markets is
termination are central to economics. Geo- also provided.
graphic markets are particularly relevant Contemporary
to ag- studies of economic markets
riculture because agricultural products are (and definitions of a market) are usually based
typically bulky and/or perishable and areas of on the fundamental definitions of Cournot and
production and consumption are separated; hence, Marshall. Two regions are in the same eco-
transportation is costly. The geographic bound- nomic market for a homogenous good if the prices
aries of a market are important in the measure- for that good differ by exactly the interregional
ment of supply and demand, in price discovery, transportation cost. Alternative statements of this
and in the structure of competition. Despite this same arbitrage concept are that (a) the regional
importance, Stigler and Sherwin (p. 555) have markets are integrated (Goodwin and Schroe-
noted that "the infrequency with which one en- der), and (b) the law of one price holds between
counters actual market size determinations out- the two regions (Carter and Hamilton; Good-
win, Grennes, and Wohlgenant).
side the antitrust area is surprising and perhaps
disquieting." However, a methodology devel- The failure of two or more regions to adhere
oped recently by Spiller and Huang to define to the law of one price may be explained by one
wholesale gasoline markets geographically or maymore of the following considerations: (a) the
contribute importantly to this line of inquiry.regions
This are not linked by arbitrage, i.e., they
paper extends the Spiller and Huang approach
represent autarkic markets (Spiller and Huang);
to measure arbitrage efficiency and adapts(b)the
there are impediments to efficient arbitrage,
methodology to an agricultural markets context.
such as trade barriers, imperfect information, or
risk aversion (Ravallion, Buccola 1983); or (c)
there is imperfect competition in one or more of
Richard Sexton is an associate professor, Catherine Kling is an as-
sistant professor, and Hoy Carman is a professor and chair, De-
the markets (Stigler and Sherwin, Faminow and
Benson).
partment of Agricultural Economics, University of California, Davis. This latter point is relevant because a
This is Giannini Foundation Paper No. 962. normative conclusion often drawn from market
Thanks from the authors go to Julian Alston, Richard Green, and
integration
two anonymous reviewers for helpful comments and suggestions analysis is that observance of the
on an earlier draft of this manuscript. Marshallian arbitrage condition across markets

Copyright 1991 American Agricultural Economics Association

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Sexton, Kling, and Carman Market Integration and Efficiency 569
n n
implies the existence of efficient, competitive
arbitrage forces. However, Faminow and Ben-
son have observed recently that this conclusioni=l j=o
(3)
is justified only for the prototype point-space
trading model wherein "effectively, The all buyers
test of short-r
and sellers [within a region] are located
esis at a y0
sin- = 1.0, yj =
gle point" (p. 49). i, while the corres
Information on market integration may, there-
condition
Theto
fore, provide specific evidence as recent
the contributions
com- requir
of Goodwin and
Schroeder andof
petitiveness of markets, the effectiveness Goodwin,
ar- Grennes, and Wohl-
genant
bitrage (Carter and Hamilton), and the are in the same spirit. As Goodwin and
efficiency
of pricing (Buccola 1983). However,
Schroederasnote
Fami-
(p. 174): "Interregional trade takes
now and Benson's work demonstrates, it and
time to arrange may to complete. Because of de-
be difficult to discern the specific cause(s)
livery lags, of
trade between regions is conducted
observance or failure to observe the law of one
based upon expectations of future market con-
price. This point will be developed further inditions"
the (emphasis added). Thus, these authors
following discussion. construct rational expectations models of arbi-
trage wherein the market integration condition
is one of transportation-cost-adjusted equality
Previous Approaches between current price in the exporting region and
expected future price at the delivery time in the
The traditional methodology to study market importing
in- region.
However, in competitive markets with con-
tegration relies on correlations between the prices
in pairs of regions (Richardson, Horowitz). tinuous
For trade, failure to observe short-run inte-
example, a typical regression model to testgration
for of prices implies normative inefficiency
short-run market integration might be in the arbitrage process. Thus, although long-
run integration may be regarded as the more re-
(1) P =3 +P + 2 T, + e,. alistic equilibrium concept, short-run integra-
tion remains a normative benchmark for market
where Pt, i = 1, 2 is the price in region i at time
evaluation.
t for a homogenous good, T, is the transactions
Also short-run market integration may be a
cost at t required to ship a unit of the good be-
more realistic equilibrium condition than the
tween the two regions, and e, is a random error
preceding authors imply. For example, in the
term. A test for short-run integration is provided
common trade scenario where one region or
by the joint hypothesis:
country is a dominant exporter shipping to many
(2) Ho: po = 0, 31 = 12 = 1.0. importers, the flow of product from the exporter
to the various importers is nearly continuous.
Because common shifts in supply and demandThus, the efficient arbitrage response to a rel-
may induce substantial correlation among theative price increase for importer A is not nec-
P' even without interregional arbitrage, analysts essarily new shipments to A from the exporter
have considered variations of equation (1) basedbut, rather, a rerouting of shipments from other
upon correlations of price differences (Stigler and destinations to A. Depending upon the geo-
Sherwin, Carter and Hamilton). graphic constellation of importing regions/
Researchers have also become increasingly countries, this adjustment process may occur very
concerned with distinctions between short- and quickly, making the law of one price a realistic
long-run market integration. As Ravallion ar- short-run equilibrium condition.
gues: "in many settings it will be implausibleFaminow and Benson's concern is not the
that trade adjusts instantaneously to spatial price
methodology of market integration analysis but
differences, so one would be reluctant to acceptrather the interpretation of estimation results,
short-run market integration as an equilibrium
which they show hinges critically on the as-
concept" (p. 103). The model proposed by Ra- sumed model of spatial competition. Most prior
vallion to test for short- versus long-run inte-
work has been interpreted from the perspective
gration involves correlating price in one region
of the standard point-space trading model (Tak-
with lagged own prices and contemporaneous ayama and Judge) common to international or
and lagged prices in another region. For ex- interregional trade analyses. Here, production
ample, and consumption regions are geographically

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 570 August 1991 Amer. J. Agr. Econ.

separate competition and

proach is capable of is usually
addressing a number ofcon
only as it in
emanates
market so far
from
integration questions relevant multi
to agri-
ers (buyers) located at
culture. Our theto production
application fresh celery markets
sumption) point. provides an illustration and helps to highlight
Benson and Faminow note,
some of the however,
points raised by Faminow and Ben-tha
intraregional trading
son. model (e.g., Gre
Norman, and Hung) may be more app
in arbitrage analysis for some agricultur
The Basic Model and Extensions
modities. This model embodies a spatia
bution of both buyers and sellers alon
The SH model is constructed in the point-space
line or appropriate two-dimensional s
tradition and applicable to separate regions that
Competition is then usually from spati
have their own supplies and demands for the
persed buyers and/or sellers, although m
product in question. The product may be shipped
buyers/sellers may be located at a give
at a cost across regions. Because each region
The key Faminow and Benson conclu
has its own supply and demand, it is possible to
that estimation results will be interprete
identify autarkic prices in each region. SH ex-
differently from a point-space tradin
press the reduced-form equations of autarky prices
perspective than from the perspective
for two regions at time t as
tially dispersed buyers and sellers. For ex
short-run market(4)integration
pIA = 71 + E1 may imp
competitive base-point pricing rather th
petitive FOB pricing and efficient Mar
arbitrage.' (5) p2A = 7 .2 + E '2
The main inference from these recent studies where the Tr' are constant means and the E
resent random shocks to the markets. Given free
is that the arbitrage model must be chosen and
interpreted carefully relative to the trade trade
and across regions, the actual prices, P, P ,
market structure characteristics of the product may differ from the autarky prices. Specifically,
under study. Is short-run (contemporaneous) in- if p1A _ p2A] < T, no profitable arbitrage op-
portunities
tegration a realistic equilibrium condition? Is the exist and
point-space trading model an appropriate char- pl _ pA, pt2 = 2A
acterization of the market(s), or is the model with
spatially dispersed agents a more accurate de-However, if the autarky price difference ex-
scription (Faminow and Benson)? ceeds T,, SH assume that competitive interre-
gional shipments will take place until the ob-
The Spiller and Huang (SH) model is directly
served prices in each region differ by exactly T,.
relevant to those situations when integration of
markets based on contemporaneous prices is In athis case the markets are integrated, and
realistic equilibrium condition, although the P2 p _ t,> 0,
methodology is extended in this paper to study
lagged price effects. In this context the SH where
ap- for simplicity region 2 is assumed t
proach overcomes a number of lingering meth-
the higher-price region.
odological problems in arbitrage models: (a) The Let transactions cost T, be modeled as a r
arbitrary choice of the price in one region dom as variable with constant mean, T:
predetermined is avoided. (b) Transaction costs
are estimated within the model. (c) Integration (6) T, = T + v,, where v, - N(O, o 2).2
is not treated as an "all or nothing" proposition
The probability at time t of no arbitrage
because regions often may be linked by arbi-
portunities between the two regions (i.e.,
trage in some periods, but not others, depending
probability of autarkic markets) is the const
upon the supply-demand conditions in each re-
A, where
gion at time t, as well as the magnitude of T,.
We turn now to describe the basic SH model.
A = Prob{P2A - pA < T + v,},
With the extensions proposed here, the ap-
= Prob{(n2 - 1)+ (E2 - E) - v, < T}.
' Base-point pricing is a collusive strategy whereby all sellers 2 Constant mean transactions costs over time represents a fairly
offer the same delivered price schedule consisting of price at a given strong assumption of the SH model and implies that empirical ap-
location (the basing point) plus transportation costs from the basing plications of the model require relatively short time series and/or
point to other destinations. periods of relatively stable prices.

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Sexton, Kling, and Carman Market Integration and Efficiency 571

It follows that A is a function the

of specific
vi', vr2, T, of the application to U.S.
context
celery marketing.
O'v, and the
probability distribution
of observing parameters
binding of the E . The
arbitrage (mar- California is the major celery supplier to U.S.
ket integration) at time t is 1 - A, where A - markets throughout the year, but the competi-
0 signifies regions that are almost always inte- tive structure varies by season. Shipments data
grated (in the same Marshallian economic mar- confirm that California supplies some 80% to
ket). 85% of the celery to U.S. terminal markets dur-
The above model may be expressed as a ing the summer and fall months (roughly June
through November). Nearly 90% of the Cali-
switching regression system and estimated using
maximum likelihood methods. With the SH ap- fornia crop is shipped via trucks, with most of
proach (a) prices are not treated as predeter-the remainder shipped by piggyback van. Mich-
mined variables in the regression model, (b) in-
igan is the largest of the secondary summer-fall
terregional shipment costs are endogenous and suppliers, with minor supplies also originating
estimated within the model, and (c) the proba-in New York, Ohio, Washington, and Canada.
bility that markets are integrated is allowed to California's share declines, however, during
vary continuously. the winter and spring (December through June)
when Florida enters as a major producer, ac-
counting for about 25% of total supplies. Al-
though Florida ships celery to all major terminal
Extensions
markets except those on the West Coast, Cali-
fornia celery is preferred to the Florida product
Production of many agricultural products is because
con- of higher quality, more dependable sup-
ply, and California shippers' ability in many cases
centrated in only one or a few regions and, hence,
to provide a single source for many fresh veg-
does not conform directly to the SH paradigm,
etables (Berger et al.).
wherein regions have indigenous supply sources.
For example, U.S. supplies of many fruits andBerger et al. estimate that there are ninety cel-
vegetables, depending upon the season, ema-ery growers and about forty large-scale handlers
nate mainly from California and/or Florida.and In
marketers of celery in California, with none
these cases shipments typically flow from the a large market share. Moreover, there is
having
no centralized mechanism to coordinate ship-
producing region to various terminal markets
ments in California. This structure contrasts
across the country, and the concept of regional
autarkic markets is of limited relevance. sharply with the Florida scenario, where only
about fifteen large grower handlers operate and
A question that arises in these agricultural set-
tings is whether product allocation from the pro-marketing is regulated by a federal marketing
ducing region to consuming regions takes place order featuring flow-to-market provisions. Also,
nearly all Florida celery growers belong to a
efficiently or whether periodic gluts or shortages
occur as the result of product misallocationscentralized marketing organization, the Florida
(Buccola 1983, 1985; Berger et al.). Unlike the Celery Exchange (Berger et al.). Contracts with
SH model, episodes of arbitrage failure cannot growers give the exchange title to the celery and
complete control over its marketing (Kilmer).
be attributed to autarkic market equilibria in these
cases. Rather, they must be explained by inef- Market structure analysis indicates strongly
ficiencies in arbitrage resulting from trade bar-that California celery is allocated competitively.
riers, imperfect information, and risk aversion,Although Faminow and Benson note that spatial
or by imperfect competition. markets often tend to be imperfectly competitive
The extension of the SH model developed in and provide incentives for sellers to price dis-
this paper is applicable to many agriculturalcriminate,3 a large number of sellers located at
products. These model applications will bethe same production point renders such discrim-
characterized by markets logically linked by ar-ination infeasible and competitive FOB pricing
bitrage, with tests for the efficiency and/or emerges in equilibrium. (A formal derivation of
competitiveness of the arbitrage process. Test this result is provided in Greenhut, Norman, and
results will usually allow the analyst to draw in-Hung, chap. 8.)
ferences regarding the efficiency of arbitrage with
probabilities of gluts and shortages for a given
area, the physical dimensions of the market, and 3 Spatial price discrimination occurs when "the difference in de-
livered prices between any pair of markets is not equal to the dif-
product substitutability. For parsimony of pre- ference in transports costs incurred by the firm in supplying those
sentation, however, the analysis is developed in
markets" (Greenhut, Norman, and Hung, p. 102).

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 572 August 1991 Amer. J. Agr. Econ.

Because celery (8c)

marketing is much
ordinated in Florida than California, it is im- S- Pc,, = T' + v - u with prob A2.
portant to ask whether Florida shippers exercise
Here u is a positive random variable so that
market power and practice price discrimination
(8b) defines a regime wherein the wholesale ter-
across consuming markets or whether pervasive
minal price exceeds the FOB price plus trans-
competition from California mitigates these op-
actions costs-a relative shortage situation in that
portunities.
less product was allocated to the terminal than
Focusing attention first on celery marketing
indicated by the efficient arbitrage condition (8a).
during the summer months, suppose initially that
Alternatively (8c) corresponds to a market glut,
product flows from California are efficient. Then
where the terminal price is depressed below the
denoting California FOB prices as Pc and FOB price plus transactions costs because of ex-
wholesale terminal market prices with the cor-
cess shipments relative to the efficient arbitrage
responding upper case P' i = 1, ..., n, we havestandard.
the following equilibrium arbitrage condition for
The equations in (8), thus, define a switching
a given time period t:
regression model with three regimes: efficient
arbitrage, shortage, and glut. To estimate the
(7) pc,, = P: - Ti = P2 - T2 model, the likelihood function may be formu-
= .. = P" - T". lated as follows:
Departures from (7) imply profit opportunities
that, given a perfectly competitive supply, should
trigger product reallocations from low- to high- (9) L = t=lH [Alf + A2 t + (1 - A- 2)f
price terminals to restore the equality.
However, if product is not allocated effi- where f1, f2., and f3 are, respectively, the den
ciently due to risk factors, imperfect informa- sity functions of (8a), (8b), and (8c), and n
tion, significant shipment lags, etc. (see gen-the number of observations. To specify the
erally Buccola 1983), then periodic gluts ordensities, assume that ut is distributed indepen
shortages may appear in the various terminalsdently of vt with a half normal distribution, i.e
and (7) will not hold for all t. For example, Ber-
an N(O, o"2) distribution truncated from below
ger et al. speculate that California causes peri-zero. Then define Yt = P' - pc,t and express t
odic gluts in Eastern markets during summer densities as follows:4

S 2 Y, - T -(Y1- T)o r/o>,

f2_ 2u+072).5 4 (o2 + 072).5 ()12 + T)()-z+ .2).5 ] ,
f2 +[?
f3t--4)
1 Yt, - T
(T v "

where 0(
months by making large shipments ) denotes
with "no the standard normal densi
pre-
function,
arranged destination or price" and 0( ) denotes the correspondin
(p. 35).
To extend the SH methodology cumulative
to testdistribution
for in- function for the standar
efficient product allocation, we define
normal. three re-T, A1, A2, o, and ao ca
The parameters
be estimated
gimes that exhaust the possible by maximizing
arbitrage con- the log of (9).
ditions between the producingDuring Florida's
region and winter
anyproduction cycle, the
terminal market i: Florida analogue to the California efficient a

(8a)
4 The functions f, andf are best understood through their clo
-p- p, T' + 'withprob 1 - A- A2, analogies to frontier functions (Aigner, Lovell, and Schmidt). Sp
cifically, ff corresponds to a stochastic frontier equation with a p
(8b) itive error (e.g., a cost function), while f2 corresponds to a s
chastic frontier equation with a negative error (e.g., a productio
P - pc,=T + v+u' with prob h, function).

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Sexton, Kling, and Carman Market Integration and Efficiency 573

will not reflect

bitrage condition, (7), can be formulated and the full incremental transport costs
also
(Greenhut,
tested via (9), but these results must be Norman,
inter- and Hung).
preted in a manner consistent with the spatial
To incorporate spatial price discrimination into
an (Faminow
market structure for Florida celery SH-type arbitrage
and model, define M' as an in-
Benson). Spatial price discrimination is a con-
cremental
cern given Florida's marketing market
order, i inmark-up
addition to
Celery the transactions
to the price, Pi, at costs,
terminal
Exchange, and insulation from T'. It follows
nearby that M' > 0 implies a price mark
spatial
competitors. Although Taylor and Kilmer
up over the FOB con-
price and M' < 0 implies freight
cluded that "the weight of empirical
absorption. evidence
The equation for delivered Florida
price toindustry
S. . suggests that the Florida celery any terminal market i is thus:
has not enhanced price above [the competitive
level]" (p. 41), this conclusion was derived
(11) P,,, = p,,from + T',t + M't.
an aggregate conjectural variationsThe
model
modified ofSH oli-
model summarized in (8), and
gopoly which may fail to capture (9)spatial
cannotmarket
formally distinguish the two com-
power in specific consuming regions.
ponents
Thus, to explore this issue further
That of the
using
is, the PF, an
- p,t,,price
coefficient, T' from difference
maximizing in
the(11).
arbitrage model framework, note that
log of a include
(9) will priceboth T' [see eq. (6)] and
discrimination equilibrium for Florida would
a sample average for be
M'. However, if reason-
able inferences about the relative magnitudes of
(10) MRI, - TI-, = MR2,t - T, the T' can be made across the various spatial
= MRnF, - Tn, <markets,
PF,t,perhaps inferences about spatial price
where the MR',, denote marginal revenuecan
discrimination be generated from an SH ar-
from
Florida celery sales to the various bitrage
terminalmodel. mar-
kets i at time t, and T,,t are the corresponding
per unit transactions costs. The Florida grower
Price Premia
price, p,I,, represents a blend price based on
revenues from the various terminal markets.
Marginal revenue in each terminal market isAde-
final extension of the SH model with a direct
rived, in turn, in the usual fashion from the re-
application to celery marketing concerns tests of
sidual demand facing Florida shippers in the product range. Although agricultural prod-
that
market. ucts often are considered homogenous, subtle,
Florida's residual demand is essentially but
thepossibly important, product differentiation
market celery demand less the competing may Cali-exist among nominally similar products.
Examples
fornia supply at each price.5 If Florida has no are similar products grown in differ-
entisregions, different varieties of a particular crop,
market power, residual demand for its celery
or meat products with variable characteristics,
perfectlytoelastic,
collapses MR',, = Pr,,,
the competitive for all i, condi-
equilibrium and (10) such as the degree of marbling.
tion, (7). Two factors suggest, however, that Two products or varieties of a product belong
Florida may face relatively inelastic residual de- in the same product market if they are close sub-
mands in those consuming regions nearest to it: stitutes (Stigler and Sherwin). The most general
(a) Florida has a decided transportation cost ad- approach to measurement of substitutability is
vantage over California in these markets and, estimation of cross elasticities of demand, but
hence, is less vulnerable to offsetting California data deficiencies and econometric problems may
shipments, (b) for most functional forms, de- render this method impractical (Baker and Bres-
mand becomes more elastic as a function of dis- nahan), especially for products that are close
tance from the producing to consuming region substitutes. Yet, specific evidence on the sub-
(Greenhut, Norman, and Hung). In these cases, stitutability of products believed a priori to be
price discrimination will favor more distance close substitutes will be important when precise
markets in that delivered price to these markets product and market definitions are at issue. (For

6 Stigler and Sherwin have also observed that tests of geographic

5 This definition of residual demand is technically correct only market definition may also be applied directly to questions of prod-
for the case where Florida and California celery are perfect sub- uct substitution.
stitutes. As noted, some evidence, including our own empirical re- 7 For example, the closer the substitute relationship between two
sults, suggests that buyers view Florida and California celery as products, the more colinear their prices will be, making it imprac-
somewhat differentiated products. Baker and Bresnahan derive re- tical to include both prices as explanatory variables in demand func-
sidual demand functions for the differentiated products case. tion estimation.

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 574 August 1991 Amer. J. Agr. Econ.

example, see Hayes, Wahl,

Estimation and Williams f
attempt to test perfect substitutability in an
framework.) The switching regression models were estimated
The SH methodology may
using weekly also
price data be
for U.S. extend
celery for the
to address a hypothesis that
four-year period, two
January goods
1985 through Decem- are
fect substitutes (in the same
ber 1988. Shippingproduct
point and terminal market)
market
prices were relationship
key point is that a stable obtained for both California mustand
between the prices Florida
of celery
two from perfect substit
various USDA Federal-State
Specifically, we define
Market News perfect
Service reports.substitutab
All prices were
as the existence of ina stable
terms premium
of dollars per crate.9 California's (poss
pro-
zero) separating the prices
duction ofbut
is year around, two produc
the producing area
our application California and
shifts seasonally. Thus, Florida celery.
Central Coast prices were
is, used during the summer and fall, and South Coast
prices were used in the winter and spring. The
(12) P ,t - PF, = a' + l1, i = 1, ...., n, Florida analysis was based on data from Flori-
da's December through May production period.
where a' > 0 represents the price premium, and Two criteria were used in selecting terminal
t -~ N(0,(o')2). If California and Florida ce- markets for inclusion in the study: (a) signifi-
lery are perfect substitutes, then during all pe- cance of the terminal as a receiver of celery, and
riods when both regions ship to a consuming area, (b) location of the terminal. The five largest U.S.
arbitrage forces will ensure that the two prices terminal markets, Boston, Chicago, Los Ange-
diverge by the premium, a'.8 However, if the les, New York, and San Francisco, were in-
two products are not perfect substitutes, then their cluded under the first criterion, and Atlanta was
price difference may systematically range above chosen under the second. 10 However, Florida does
or below a' in response to variations in each not ship celery to the West Coast, so the anal-
product's individual supply-demand factors. ysis for Florida shipments was limited to Chi-
The three regimes of our model of geographic cago, Boston, New York, and Atlanta.
arbitrage efficiency correspond exactly to the
model to test for stable price premia (perfect
substitutability). That is, we can define three re- California Celery
gimes to exhaust the arbitrage possibilities across
The maximum likelihood estimation was con-
alternative product forms:
ducted using the DFP routine in the GQOPT
(13a) package. Results from estimation of (9) for Cal-
ifornia-origin celery are summarized in table 1.
PCt, - PF,t = a' + ? with prob. 1 - A1 - A2 Most of the estimated coefficients are statisti-

(13b) cally significant. The probability, 1 - A1 - A2,

of efficient arbitrage is high, not surprisingly,
PC,t - PF,t = a' + ' + u? with prob. A1
in Los Angeles (0.76) and San Francisco (0.83),
(13c) those cities nearest the production regions.
However, in all cases the Ai are either individ-
PC,, - PF,, = a' + , - u' with prob. A2, ually or jointly significant causing a rejection of
the hypothesis that arbitrage is efficient or that
where all variables are defined as in (8). The
the law of one price holds for all t.1"
hypothesis A1 = A2 = 0 tests whether the prod-
The less efficient arbitrage in the eastern mar-
ucts are perfect substitutes, and, qualitatively
kets is consistent with prevailing views on pric-
speaking, the magnitude of A1 + A2 is inversely
related to the strength of the substitute relation-
ship. Conditional upon rejecting A1 = A2 = 0, 9 The standard celery crate weighs 60 pounds. The number of
stalks per crate varies with the size of the celery. Our prices were
differences in A1 and A2 can be analyzed to de-
usually based on 2.5 dozen stalks per crate. Market News prices
termine possible asymmetries in the substitute are often reported in ranges. In these cases we chose the lower
relationship. bound of the price range for analysis. The rationale for this choice
is provided by SH (p. 137).
10 Industry experts suggested that about 60% of fresh celery is
marketed through the terminals, with the rest contracted directly to
8 For example, if P j, - PE, > a', then buyers will bid upmajor
the retailers.
" For Atlanta and Boston joint significance of the A, was estab-
price of Florida celery relative to California celery to restore the
equality in (12). lished based on the usual likelihood ratio tests.

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Sexton, Kling, and Carman Market Integration and Efficiency 575

Table 1. Parameter Estimates for California Celery Arbitrage

Los Angeles San Francisco Chicago Boston New York Atlanta

T 2.35 3.83 5.45 4.84 4.53 6.31

(28.28)a (32.66) (1.86) (5.82) (11.02) (23.13)
02 0.62 1.28 0.33 0.87 1.05 0.94
(5.28) (5.39) (1.68) (2.14) (3.24) (1.74)
02 3.94 7.97 2.23 2.65 3.53 3.20
(3.52) (2.29) (5.61) (2.42) (4.46) (1.20)
A1 0.15 0.12 0.55 0.78 0.61 0.00
(2.27) (1.80) (3.69) (1.69) (2.46) (0.00)
A2 0.09 0.05 0.26 0.04 0.03 0.18
(16.12) (1.27) (2.60) (0.63) (0.95) (1.31)
1 - A1 - A2 0.76 0.83 0.19 0.28 0.36 0.82
Log likelihood -323.44 -379.47 -367.42 -373.22 -391.90 - 193.15
Observations 209 209 209 209 209 122
T as % of
mean price 28 38 46 41 40 52
a t-statistics are in parentheses.

ing efficiencyactions
(Buccola
costs in the model (see 1983,
footnote 2), pos- 19
ample, the risk sible
in making
trends in transportation costsunconsig
over the period
likely increases of analysis
with are of concern.
shipment
Monthly shipping- d
time lags, possible losstruck
point-to-terminal-market in quality
transportation costs
and quality of information per crate of celery for the 1985-88on period ofmar
may also decline asobtained
analysis were a function
from the U.S. Depart- o
tween shipping mentpoint and Marketing
of Agriculture, Agricultural receiv
Atlanta result, 1 Service
-(USDAAA AMS), but
- observations
A2 = were0.82,
the results for the other eastern terminal markets available for only Atlanta, Chicago, and New
but is explainable by Atlanta's close proximityYork. These data were tested for trends in trans-
to Florida production. That is, through the sub- portation costs during the period; no statistically
stitute relationship, a glut or shortage of Cali-significant time trend was detected in these per
fornia celery can be corrected by an adjustment crate charges. This result supports the assump-
in either the California supply or the competingtion that mean transactions costs were constant
supply from nearby Florida. over this four-year period.12
Particularly relevant are the comparative As noted, celery marketing exhibits a sea-
magnitudes of the Ai. In each of the marketssonal pattern coinciding with Florida's winter-
spring production cycle versus summer-fall
studied, except Atlanta, A I > A2. Thus, each of
the five major terminals was more often char-marketing when California competes with a
acterized by relative undersupply than oversup- number of small northern suppliers. Also, truck
ply of celery, and no support is found for theshipment rates often exhibit a seasonal pattern,
Berger et al. conjecture that California causes with higher rates during summertime peak de-
market gluts in the major eastern markets. mand periods. For these reasons the arbitrage
The estimates of mean arbitrage costs in table model defined in (9) was estimated separately
1 are all highly significant. With one exception, for the December-May and June-November
Chicago, T'c is increasing in distance from the periods. The results are contained in table 2.13
producing area. The Chicago result may signal No seasonal pattern in the probability of ef-
relative inefficiencies or imperfect competition ficient arbitrage is evident in the Los Angeles
in the Chicago-area transportation and market- and San Francisco markets. This result is not
ing network. Also interesting is the significant
portion of wholesale California celery prices that 12 A second analysis involved subtraction of transportation costs
is due to shipment costs. This figure ranges fromfrom the terminal market price and estimation of the switching
regression model for Chicago and New York. Except for the an-
28% in Los Angeles to 52% in Atlanta, based ticipated differences in the magnitude of T, the probabilities of binding
on mean 1985-88 wholesale prices. arbitrage were essentially unchanged: 0.15 in Chicago and 0.39 in
Transportation costs typically account for aNew York versus 0.19 and 0.36, respectively, in table 1.
13 Seasonal models were not run for Atlanta because ot limited
major portion of total transactions costs. Be-observations. No California celery price was recorded in Atlanta
cause of the assumption of constant mean trans-for many weeks because of insufficient shipments.

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 576 August 1991 Amer. J. Agr. Econ.

surprising because these markets are served

clusively by California supplies and, henc
relatively insulated from changes in the sea
k
It c-, ot "1 t00 O oo8 production pattern. In contrast, a seasona
Q)
Vq~ V) It O Or 00 C O z Ct
E tern does emerge in the major midwester
E
1 I
eastern terminals. In all three cases the esti-
k rn
o
$1 mated probability of efficient arbitrage is greater
in the winter than summer and in all cases Ah
Z k (A2) is higher in the summer (winter).'4
- 00 M These results indicate that it is more difficult
3
for California shippers to engage in efficient ar-
bitrage in the summer-fall months than in the
O 00 '--- C t -- outcome
00mayO
- winter and spring.
e? This well be
k 00 V) r 00 C C n0000000

-- O O0 V* 8 C,10 -o
Q)
E - I 00 -
E caused by unpredictable patterns of supply by
1
a rn the small, northern celery suppliers during these
S
r~
O
months. Efficient arbitrage during winter-spring
CC) months is likely simplified by the presence of a
u
single main competitor, Florida, with a coor-
3 dinated marketing mechanism. In particular,
Florida supplies likely are easier to predict and
k
Q)
,--. tt O t3 U U J- -O monitor
oo O r- than,l
supplies from the small northern
E producers, and, as noted, through the substitute
E 0 00 0 -

O rn
1 relationship, Florida shipments may be quite ef-
Q) 3 fective in eliminating gluts or shortages for Cal-
o

0r-00 z t CIt 0 CO N 000 0 0

ifornia celery.
U k M-r N-c coo M q M M -O
Also interesting to note is that the estimated
blD
t t000 0
transactions costs, T c, are not consistently higher
in the summer and fall despite generally higher
truck shipment charges during these months. In
fact, in three of the five cases the estimated win-
k
Q)
E t r . 00 066
o
OE ter-spring margin was higher, indicating that
y~l
o
rn other components of the margin rise in the win-
k ter and spring to offset lower truck rates.
ct
t ,--- , ---. -", tt3 - ooO - o t " "
rn a

Florida Celery
E

k
The results from estimation of the arbitrage model
11
Q) OW) W)N Nt3 " t - O tt ,---
E for Florida celery in table 3 must be interpreted
r~
E INr cautiously because of the market power consid-
erations discussed above. The probabilities 1 -
AI - \A2 are very similar for all of the Florida
r~
Ok markets analyzed, ranging from 0.35 to 0.44.
a However, it is difficult to provide a firm inter-
pretation of this result. If Florida acted as a
competitor in these markets and engaged in FOB
o
pricing, the relatively low values for 1 - A1 -
N
^A2 would indicate a failure on Florida's part to
0

vl
14 Likelihood ratio tests were used to test the hypothesis of no
seasonal structural change. The values of the test statistic were San
Francisco: 3.94, Chicago: 6.82, and Boston: 19.96. The pooled
model in table 1 imposes 5 restrictions and X2,o os = 11.1. Thus,
we reject formally the hypothesis of no seasonal structural change
for Boston but not for Chicago or San Francisco. (Similar tests
were not performed for Los Angeles and New York because in each

case the nonnegativity

summer-fall model.) constraint A, - 0 was binding for A, in the

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Sexton, Kling, and Carman Market Integration and Efficiency 577

Table 3. Parameter Estimates for Florida Celery Arbitrage

Chicago Boston New York Atlanta

T 4.58 2.33 1.93 2.76

(14.79)a (14.45) (8.84) (19.74)
2v 0.37 0.30 0.42 0.16
(2.01) (2.59) (1.24) (1.89)
au 2.89 2.10 2.83 1.89
(2.86) (3.83) (2.98) (4.57)
A, 0.06 0.23 0.49 0.16
(0.98) (2.21) (3.35) (2.61)
A2 0.57 0.33 0.07 0.49
(2.34) (2.94) (0.57) (3.82)
1 - A1 - A2 0.37 0.44 0.44 0.35
Log likelihood -81.53 - 173.21 -99.21 - 170.82
Observations 48 111 61 116
T as % of mean price 41 25 20 29
a t-statistics are in parentheses.

engage in efficient arbitrage

transactions despite
costs involved in marketing celery.
nated marketing They clearly suggest, however, a significant
mechanism. Howev
sult could also reflect markup above competitive FOB prices
dynamics inin At-the
crimination equilibrium lanta and a healthy (10).
amount of freight
The absorption
price
term, Mi, in equation in New York, (11)
just as themay
relevant spatial theory
change
riod to period in (Greenhut,
response Norman, and Hung; to Faminow
variatio and
ida's residual demand Benson) predicts. elasticity ca
changes in competing supplies.
Florida is a minor supplier in the Chi
ery market, with an average 2.4%
Some Dynamics
1985-88. The T' for Chicago in table
paratively high, as Becausewas true
of the concerns about for Califo
short- versus long-
ments. Florida is run a equilibrium
morein significant
arbitrage (Ravallion, Good- pl
Boston and New York markets with 26.8% and win and Schroeder, Goodwin, Grennes, and
17.8%, respectively, of total fresh marketWohlgenant),
sales the extended SH arbitrage model
during the 1985-1988 period of analysis.for The
California celery was reestimated for alter-
T' for these geographically proximate terminals
native formulations of the arbitrage condition.
are similar, $2.33 and $1.93 for Boston and New the prototype model in (8) assumes that
Whereas
York, respectively. integration between contemporaneous FOB and
The most interesting facet of the Florida terminal
anal- prices is the relevant equilibrium con-
ysis is comparison of the Boston, New York, cept, alternative formulations may be based on
and Atlanta markets. Florida is the dominant lagged price relationships as suggested by
seller in Atlanta during the winter. In fact, Goodwin,
dur- Grennes, and Wohleganant.
ing some weeks, few, if any, California ship- A price determination process whereby the law
ments occur. Although Boston (New York)
of is
one price may emerge for lagged prices can
roughly 850 (650) miles farther from the Florida
be motivated as follows: California FOB prices
areof
producing regions than Atlanta, our estimates based on current supply and demand con-
the T' indicate that the margin per crateditions
was facing shippers. This demand, in turn, is
derived
actually $0.43 less for Boston and $0.83 less for from retailers' demands and demands in
New York than Atlanta. This result is evidence the terminals markets. No single terminal is apt
that Florida is employing a discriminating to spa-
be large enough to have a significant influ-
ence on the FOB prices. Weekly terminal
tial pricing system of the type described previ-
wholesale prices are based on supply-demand
ously. Per crate truck shipment rates for celery
gathered by the USDA AMS further document conditions in that market. When, for example,
this result. These rates were not available for
Pc > pc,t + T', a profit opportunity for ship-
Boston, but the average over 1985-88 was $2.54
ments to market i is signalled if shipments occur
for New York and $1.06 for Atlanta. Truck instantaneously. The same market signal is re-
shipment rates represent only a portion of ceived
the when shipments occur only with a time

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 578 August 1991 Amer. J. Agr. Econ.

lag if the contemporaneous price is u

expected future price, i.e., E,[P+ ,] =
If shipments arrive with, say, a j pe
the relevant integration condition i C14 m ?o 00 WI)O00 00

Pc,t and P ,j. Given the speed of transc

truck shipments, the longest feasible la
sider for celery is one week. To test
price integration, the extended SH a
a~ ~-~ ~O O -O O o
model was reformulated and estimated
natively substituting PI+1 or (P. + P co

P: everywhere in (8) and redefining

oo

ingly in specifying o,
the6 f't.
Results from estimating I "
these
Cl N
models
vided in table 4 where the models based on 00 M r- 60 0

P:+l and (P +? P+l,)/2 are denoted as the

"lagged" model and "average" model, respec-
tively. Results for the prototype model (8) (table 0 N

1) based on contemporaneous prices are in-

cluded for comparison. 16 C
t C 0 00Nl t
Eo
The table shows that the probability, 1 - A1
- A2, of observing binding arbitrage in the Los
Angeles and San Francisco terminals is similar
across the three arbitrage conditions. This result
is again consistent with their proximity to the 0000 ?o 0 00

production region. However, the probability

0
of
observing the lagged arbitrage regime, P , -
Pc,, = Tl + v', is greater in each of the eastern
and midwestern markets than is the probability
0
L
of observing contemporaneous arbitrage, P -
pc,, = T' + v . This result provides some sup-
Q u

port for the hypothesis of lagged adjustment

*A
0
to
market conditions as distance from the produc-
]
Cl000- lN r- 0 , rC N W

ing to the consuming region increases. The

U 0~
2 N
b
probability of observing the "average" relation-
c
x~~~-d m

U
ship, (P,
greater + P +1)/2
in these three -terminals.
pc,, = T' + v,,0) is even
Further information on the dynamics aof price
response in this market is obtained by? compar-
ing the log likelihood values in the table.
0
For *-

this purpose the contemporaneous integration

model was reestimated to reflect observations
lost in the lagging process (n = 207 vs. n =
0
209). This likelihood value is denoted as the
"comparison likelihood" in the table.17 The log
likelihood is greatest for the contemporaneous C ,4

integration model for both Los Angeles and San

Francisco, but the model using the average of -00~ N -~ II
E O fn -z ?
P and P ,+ generates the greatest log likelihood

15 This formulation is merely the condition that celery pric

martingales (Alchian), i.e., the mathematical expectation of t
ture price is the current price.
16 Atlanta was not included in this analysis because the per
absence of California prices made it difficult to handle the l
"7 Results tor the contemporaneous integration model for n
and n = 207 are nearly identical; hence, only the n = 209
are reported.

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Sexton, Kling, and Carman Market Integration and Efficiency 579

Table 5. Parameter Estimates for Price Premium Model

Chicago Boston Atlanta New York

a 0.76 2.90 2.57 2.31

(1.24)a (4.70) (2.84) (9.42)

a, 0.34 0.47
(0.42) 0.56
(1.21) (0.61)0.04
(0.09)
au 1.66 1.53 2.01 3.65
(2.04) (2.04) (2.03) (7.80)
Al 0.71 0.39 0.57 0.45
(1.84) (1.56) (1.18) (4.61)
A2 0.29 0.60 0.42 0.55
(1.12) (2.07) (1.13) (4.84)
1 - Al - A2 0.00 0.01 0.01 0.00
Log likelihood - 89.63 - 208.48 -124.56 - 195.76
Observations 53 119 66 63

a t-statistics are in parentheses.

in the midwestern and eastern terminals. These plied it in an agricultural markets setting. One
extension was to regions known to be linked in
results thus provide support for an arbitrage model
based on contemporaneous prices in terminals
trade, specifically the common situation in ag-
riculture of one or a few localized production
near the producing area and on a short lagged
price relationship elsewhere. areas. When perfect competition in product al-
location and FOB pricing can be safely as-
sumed, this extended model allows for tests of
Price Premia Results
three regimes: (a) efficient arbitrage (i.e., the
law of one price), (b) relative shortage, and (c)
The final aspect of the empirical analysis in-
relative glut. A second extension enabled lim-
volved direct comparison of California and Flor-
ited testing of products' substitutability in de-
ida celery prices in the various terminalmand.
mar-
kets. The results from estimation of the price
Results from application of the extended
premium model (13) are provided in table 5. The
models to celery marketing indicated that Cali-
estimated price premia, &i, are similar for the
fornia shipments to out-of-state markets in nearly
Atlanta, Boston, and New York markets, rang-
all cases departed with significant probability
ing from $2.31 to $2.90 per crate. The ~' is much
from the efficient arbitrage condition. However,
lower, $0.76, in Chicago, but its t-statistic in-
dicates that this coefficient was estimated im- no evidence was found to support the hypoth-
esized eastern market glut scenario. The prob-
precisely.
ability of binding arbitrage did increase sub-
The most interesting facet of this analysis is
stantially with the introduction of lags associated
that the estimated probability, 1 - A1 - A2, of with physical transfer of the product from Cal-
observing a stable price premium is nearly zero
ifornia to distant markets. A seasonal pattern in
in each of the markets. It bears repeating that if
California marketing efficiency was detected in
buyers viewed California and Florida celery as
midwestern and eastern terminals, with efficient
perfect substitutes subject to a price premium,
arbitrage apparently made easier in winter-spring
then buyer arbitrage should ensure that prices
months by the presence of a single main com-
diverge by exactly the premium whenever prod-
uct from both states is available. Thus, the con- petitor, Florida, versus many small northern ri-
vals in the summer-fall months.
clusion is that buyers do not view California and
Interpretation of results from analysis of Flor-
Florida celery as perfect substitutes, and their
ida celery was difficult because of concerns that
price difference is free to vary somewhat above
or below the estimated premium in response to
Florida may practice spatial price discrimina-
market conditions. tion. Comparison of results for the various ter-
minals tended to support the position that Flor-
ida charges prices well above the FOB level in
Conclusions the nearby Atlanta market and absorbs some
portion of freight charges in New York. The
This paper has extended Spiller and Huang's Florida results highlight that the failure to ob-
methodology to test market integration and ap- binding arbitrage across pairs of markets
serve

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 580 August 1991 Amer. J. Agr. Econ.

may be due to autarkic markets,

Agr. Econ. Agr. ineffi
Econ. Rep. No. 517, Michigan State
bitrage, or imperfect
University, Oct.competition.
1988. U
possible Buccola, S. T.some
to rule out "Pricing Efficiency
of in Centralized
these and co
ations, it will be Noncentralized
very Markets." Amer. J. Agr. Econ.
difficult to 67 offe
(1985):583-90.
explanation for a failure to observe t
"Risk Preferences and Short-Run Pricing Effi-
one price.
ciency." Amer. J. Agr. Econ. 65(1983):587-91.
The methodology illustrated in this paper is Carter, C. A., and N. A. Hamilton. "Wheat Inputs and the
parsimonious in its data requirements, needing Law of One Price." Agribus. 5(1989):489-96.
only time-series price data for alternative cities, Faminow, M. D., and B. L. Benson. "Integration of Spa-
regions, countries, or product forms. Yet, by tial Markets." Amer. J. Agr. Econ. 72(1990):49-62.
exploiting the flexibility of the approach and the Goodwin, B. K., and T. C. Schroeder. "Testing Perfect
available economic theory concerning the un- Spatial Market Integration: An Application to
derlying market structure, evidence may be gen- Regional U.S. Cattle Markets." N. Cent. J. Agr. Econ.
12(1990): 173-86.
erated on a number of market parameters in-
Goodwin, B. K., T. J. Grennes, and M. K. Wohlgenant.
cluding market integration, arbitrage efficiency,
"A Revised Test of the Law of One Price Using
magnitude of marketing margins, product sub-
Rational Price Expectations." Amer. J. Agr. Econ.
stitutability, and competitiveness of markets. 72(1990):682-93.
In many cases more detailed information will Greenhut, M. L., G. Norman, and C. S. Hung. The Eco-
be needed than can be provided by an approach nomics of Imperfect Competition: A Spatial Approach.
that relies solely on price data. Of course, the Cambridge: Cambridge University Press, 1987.
downside to detailed structural market models is Hayes, D. J., T. I. Wahl, and G. W. Williams. "Testing
their demands on data, which often compel un- Restrictions on a Model of Japanese Meat Demand."
desirable levels of aggregation and use of du-Amer. J. Agr. Econ. 72(1990):556-66.
Horowitz, I. "Market Definition in Antitrust Analysis: A
bious proxies for otherwise unmeasurable vari-
ables. Regression-Based Approach." S. Econ. J. 48(1981):1-
16.

[Received May 1990; final revision receivedKilmer, R. L. "A Review of the Current Pricing Systems
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sour. Econ. Dep. Econ. Info. Rep. No. 171, Univer-
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Ravallion, M. "Testing Market Integration." Amer. J. Agr.
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