Sell low and buy high: Arbitrage and local price effects in Kenyan markets
This paper (PDF) by University of California, Berkeley explores the role of financial market imperfections in contributing to farmers’ apparent inability to exploit arbitrage opportunity. Large and regular seasonal price fluctuations in local grain markets appear to offer African farmers substantial inter-temporal arbitrage opportunities. These opportunities remain largely unexploited: small-scale farmers are commonly observed to “sell low and buy high” rather than the reverse. A field experiment in Kenya shows that credit market imperfections limit farmers’ abilities to move grain inter-temporally. Providing timely access to credit allows farmers to buy at lower prices and sell at higher prices, increasing farm revenues and generating a return on investment of 28%. Significant effect of the credit intervention on seasonal price fluctuations in local grain markets are revealed. Furthermore, general equilibrium (GE) effects shape individual level profitability estimates. The results indicate a setting in which microcredit can improve firm profitability, and suggest that GE effects can substantially shape microcredit’s effectiveness. Failure to consider these GE effects could lead to underestimates of the social welfare benefits of microcredit interventions. When implemented in rural or fragmented markets, microcredit interventions may lead local prices to respond substantially enough to alter the profitability of these interventions for direct beneficiaries and to impact the welfare of non-beneficiaries. The absence of financial intermediation can be doubly painful for poor households in rural areas. Lack of access to formal credit causes households to turn to much more expensive ways of moving consumption around in time, and aggregated across households this behavior generates a large scale price phenomenon that further lowers farm income and increases what most households must pay for food. This suggests that expanding access to affordable credit could reduce this price variability and thus have benefits for recipient and non-recipient households alike.