"Technical Analysis in Financial Markets"

for trading. The CSCE and LIFFE cocoa futures contracts differ somewhat in their specifications. First, cocoa is grown in many regions in Africa, Asia and Latin America and therefore the crops differ in quality. In the futures contracts a benchmark is specified and the other crops are traded at premiums. The benchmark in the LIFFE contract has a higher quality than the benchmark in the CSCE contract. Therefore the benchmark in the LIFFE contract is traded at a $160/ton¹ premium in the CSCE contract. Second, the place of delivery in the CSCE contract is near New York, while the places of delivery in the LIFFE contract are nominated warehouses at different places in Europe. Third, the tick sizes of the CSCE and LIFFE contract are respectively one Dollar and one Pound. Cocoa producers and farmers hedge their price risk exposure with futures contracts. This guarantees them that they buy or sell cocoa against a predetermined price. The futures price will depend on the current and expected future demand and supply. When new information becomes available the price will adapt. Normally a futures price is the derivative of the spot price and can be computed by the cost of carry relationship. But in the case of soft commodities such as cocoa the spot price is not relevant, because a farmer with his crop on the land only wants to know what he can get in the future. For cocoa there is no actual spot price, but the ``notional'' spot price is in fact determined by the futures prices.

We investigate data on the settlement prices of 160 cocoa futures contracts that expire in the period January 1982 through December 1997 at the CSCE and the LIFFE², as well as data on the Pound-Dollar exchange rate (WM/Reuters) and 1-month UK and US certificates of deposit (COD) interest rates in the same period.

2.2.2 A continuous time series of futures prices

Each futures contract covers a limited time span of approximately 18 months. Thus there is no continuous time series of futures prices over a couple of years. In this section we describe how a continuous time series can be constructed out of the prices of the separate contracts. The well-known formula of the price of a futures contract at day t which expires at day T is

F_t=S_t e^{(r_t^f+u_t-y_t)(T-t)}. (1)

Here S_t is the spot price of the underlying asset at time t, and r_t^f, u_t, y_t are respectively the daily risk-free interest rate, storage costs and convenience yield averaged over the period