Volatility Formation in Dairy Futures: Fundamentals, Public Information, and Processing Ambiguity

ABSTRACT Class III milk futures cash‐settle to an administered price based on weekly component prices, creating a predictable within‐month flow of settlement‐relevant information. This paper studies drivers of cross‐month variation in realized volatility in this formula‐settled market. We separate volatility associated with upstream feed‐cost and milk‐supply conditions, downstream dairy‐product markets, USDA public information releases, processing‐related ambiguity, and market participation. Processing‐related ambiguity is uncertainty about how public dairy‐market signals translate into formula‐settled payoffs when processing capacity, inventories, product allocation, and logistics are only partially characterized in public reports. We construct a narrative measure from USDA Livestock, Dairy, and Poultry Outlook reports and distinguish it from observable public information using release‐date‐aligned innovations from major USDA dairy reports. Triple‐IV 3SLS estimates show that processing‐related ambiguity remains an economically important predictor of realized volatility after conditioning on fundamentals and broader USDA information. Weekly release‐timing specifications show stronger ambiguity effects when commercial short‐side participation is elevated.