Testing the Law of One Price under Nonlinearity for Egg Market of Selected Provinces of Iran

Regarding to the ever-increasing consumption of egg and consequently enhancement of its production during recent years, consideration to this output's market integration has special importance. Considering the fact that information on market integration may provide specific evidence as to the competitiveness of market, the effectiveness of arbitrage and the efficiency of pricing could be, likewise, useful to guide subsequent interventions aimed at improving the performance of market. In this context, in present study, validity of Law of One Price (LOP) will be tested in the egg market and among selected provinces.
Nonlinearity naturally extracted from local market due to existence of transportation and other transaction costs, so common cointegration test results are not suitable for market integration. In this study, at first, for being sure that series follow nonlinear behavior, Luukkonen et al. (1988) and BDS nonlinearity tests were used. Then for testing Law of One price in the egg market, nonlinear unit root test proposed by Emmanouilides and Fousekis (2012), which is an auxiliary regression for ESTAR model, was used. The data are daily retail prices of egg with the sample period ranging from April 2006 to march 2014 for north-west provinces of Iran including West Azerbaijan, East Azerbaijan, Ardebil, Tehran and Zanjan, which were obtained from State Live Stock Affairs Logistics Incorporated Company.
Based on the DF-GLS unit root test, the null hypothesis of unit root for egg price differentials was rejected. So, all series of price differentials are stationary. In the next step nonlinearity of price differentials of egg between two provinces was examined. In BDS test, at the beginning, an ARMA model was estimated then the test was carried out to the residual of estimated model with embedding dimension (m) 2-8 and the dimensional distance (ε) chosen equals to 0.5 and 2 times of standard deviation of the data. Based on the results from this test and Luukkonen et al. (1988) test, null of linearity was rejected and existent of nonlinear relation between series was confirmed. Then, existence of a unit root in price differential series was carried out by nonlinear method. The results showed that mentioned markets are well integrated and LOP holds in all market pairs in a way that strong version of LOP holds for all market pairs except Tehran-Ardebil that weak version LOP holds for them.
Results of this study showed that there is full transmission of shocks among selected provinces and implies that the markets considered are well integrated. It means that arbitrage activities profitably use existent opportunities and enhance economic efficiency. Moreover, the egg markets in selected provinces are taken into account as a unit market so if the government performs any kind of policy in one of these provinces (in the context of considered market), the effects of that policy will be transferred to other provinces and the welfare of consumers and producers in these provinces will be affected. Therefore, it is recommended to policy makers to regard this fact while they are choosing any new policy and to be aware of adopting the policies regionally.