Some Pitfalls in Testing the Law of One Price in Commodity Markets

Several articles find no support for the law of one price (LOP) in commodity markets. Only a few articles find some support. A rejection of the LOP would strike at the heart of economic theory. A rejection would suggest that firms do not maximize wealth and households do not maximize utility. Our objective here is to show how four common pitfalls can cause tests of the LOP to fail when in fact the LOP holds. All tests of the LOP that fail to support the theory fall in to at least one pitfall and many fall in to three or four. All of these pitfalls are the result of ignoring important practical implications of arbitrage.