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An Econometric Analysis of Malaysian Cocoa Prices: a Structural Approach
Thesis Abstract:
The cocoa industry is vulnerable to price fluctuations arising from fundamental changes in supply and demand and other technical and social factors. Consequently, price variability can affect the producers' returns and the foreign exchange earnings. This study was undertaken to investigate the main factors that determine cocoa prices.
Econometric cocoa models for the world and Malaysian markets were developed and estimated using annual time series data. Each model consisted of supply, demand, and price equations, with stock as the identity. The analyses and standard tests showed that the models were satisfactory. The R2 obtained for all the equations were above 0. 75 and most coefficients had the correct signs. The RMS percent Es were all below five percent except for the world price equation. Theil's inequality coefficients were all below 0.005. Results further showed that domestic cocoa prices were determined by prices prevailing in the world market. Domestic stock change was not significant. In the world market itself, stock and consumption were the main factors that influenced the behavior of cocoa prices. World consumption and export demand were significantly influenced by the production index of the industrial nations and cocoa price. On the supply side, cocoa production was determined by cocoa price lagged by the gestation period. This implies that investment decision on cocoa three to five years earlier was an important factor that determined cocoa supply.
The effects of market fundamentals on cocoa prices were further enhanced by the low price elasticities of supply and demand and were therefore substantial. Owing to the importance of cocoa to the economies of producing countries, it is therefore important to ensure cocoa price stability, which may be achieved by efficient price stabilization programs. Such a program can be established through improvements of the existing buffer stock program of the International Cocoa Agreement (i.e., through proper stock management). Promotion and downstream activities are alternative instruments that can be exploited to encourage demand, and therefore bolster cocoa price. Malaysia should therefore support any program that aims to stabilize the world cocoa price.