Conversely, Kaufmann (2011) points out that mileage affects price negatively, which in turn destroys the connection between two markets in terms of price. Integration between two regions weakens with the increase in distance between two distinct markets. Further, an arbitrageur risks profit due to inadequate accounting for the transportation costs involved, which causes LoP failure. Harris (2008) insists that LoP requires adjustment of price, time, and transportation for commodity arbitrage and PPP to hold. A market must be well integrated and contain stationary freight rates to allow of LoP to prevail. Integration is a critical aspect of the agricultural market where price differentials are highly volatile.
Transport costs are also components of the macroeconomic model because they help in the calculation of trade costs. Transport costs in the PPP equilibrium are dependent on the transportation methods, volumes of the goods, toll fees, and market power (Crucini, Shintani & Tsuruga, 2010). The conditions of identical goods and price uniformity are dependent on a variety of factors and apply differently for wholesale and retail commodities. The evolution of exchange rates over time has challenged the prevalence of PPP and LoP in the short run.
Taylor & Taylor, (2004) insists on the need for exchange rate adjustment to promote PPP and in turn sustain commodity arbitrage. The success of perfect commodity arbitrage depends on the ability of the arbitrageurs to adjust to different shifts in exchange rate systems. Real exchange rates adjust slowly to the PPP. Rogoff (1996) identifies nominal variables such as wages and prices as the main causes of slow adjustment to exchange rates. The arbitration of goods across geographical locations exists under perfect competition markets.
Tariffs, transportation costs, and nontariff barriers create a wedge between two prices in different countries (Goldberg & Campa, 2010). Adjustment of exchange rates comes in handy in the determination of tradability of goods. Zero transport costs and trade restrictions exist only in the integrated world market (Taylor, 2013). The essence of the exchange rate in commodity arbitrage is critical because it is a characteristic of any transaction-taking place between two countries. Exchange rate influences national price levels because it creates a link between domestic and foreign prices (Gârleanu & Pedersen, 2011).
Perfect commodity arbitrageur should consider taxes, subsidies, and
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