Identification by full adjustment: evidence from the relationship between futures and spot prices

This paper proposes a test for orthogonality of the errors in a vector error-correction model (VECM) that focuses on the recursive ordering among the contemporaneously correlated errors. The test is based on the fact that when the frequency of the data is sufficiently low one of the variables in the long-run equilibrium relationship adjusts fully within the same period to its new equilibrium level. An empirical investigation of the relationship between spot and futures prices for commodities traded on the Amsterdam Exchanges and the Chicago Board of Trade reveals that the spot price adjusts fully to its new equilibrium level if the price-discovery function of the futures market works well.