Hedging ship price risk using freight derivatives in the drybulk market

Abstract

We show that a fixed-maturity time-weighted Forward Freight Agreement (FFA) portfolio should be used to proxy the expected future earnings of a vessel. We investigate the corresponding hedging efficiency when using a portfolio of FFA prices to hedge ship price risk of both static hedge ratios calculated using Ordinary Least Squares estimation and the dynamic hedge ratios generated from a dynamic conditional correlation GARCH (1,1) model. We find that the hedging efficiency is greater for newer vessels than older vessels and that the static hedge ratio outperforms the dynamic hedge ratio. Our work is an extension of earlier empirical work which has only considered the hedging efficiency of varying-maturity calendar FFA contracts for a single vessel age.

Maximum utility portfolio construction in the forward freight agreement markets: Evidence from a multivariate skewed t copula

“…As is widely recognized in previous studies, FFA returns exhibit autocorrelation, heteroscedasticity, and non‐normality, which can be captured by the autoregressive moving average (ARMA)‐GARCH model (Adland, Ameln, et al, 2020; Alexandridis et al, 2018; Alizadeh et al, 2015; Kavussanos & Visvikis, 2010). In line with these findings, we consider the following ARMA‐GARCH model with the skewed t distribution.…”

“…Like most financial derivatives, the price discovery and the hedging functions are the two fundamental functions performed by FFAs, enabling market participants to forecast the prevailing spot freight rates and to stabilize their cash flows by hedging freight rate risks in the physical shipping markets (Adland & Alizadeh, 2018; Adland, Ameln, et al, 2020; Gu et al, 2020; Zhang et al, 2014). To obtain an in‐depth understanding of FFA's functions, this section begins with a discussion of previous findings related to the price discovery and hedging functions.…”

“…More importantly, it offers both maritime and non‐maritime market participants an alternative investment channel by trading FFA contracts, which raises a critical concern about FFA portfolio construction. Regrettably, this concern has not been rigorously examined in previous studies which focus primarily on FFA's price discovery and hedging functions instead of FFA's portfolio diversification function (Adland, Ameln, et al, 2020; Batchelor et al, 2007; Gu et al, 2020; Tezuka et al, 2012). To overcome this limitation, we analyze the maximum utility portfolio strategy by constructing FFA portfolios across shipping sectors and maturities.…”

Static Hedging of Freight Risk under Model Uncertainty

“…There is an increasing trend among academics and industry practitioners towards abandoning dynamic hedging and turning attention more and more on static hedging which is easier and cheaper to implement (see e.g. (Carr, Ellis, & Gupta, 1998), (Carr & Wu, 2014), (Leung & Lorig, 2016)) and in many cases have been proved a better option than the commonly used delta hedging (Adland, Ameln, & Børnes, 2020). Static hedging is suggested in hedging of exotic type derivatives that are path-dependent, like the ones used in shipping industry, and in many cases is possibly the only option due to the market nature (e.g.…”

Stackelberg Game Model of Railway Freight Pricing Based on Option Theory

“…In real life, consider a company that uses two channels for trading: contract and spot, and several flexibility contracts were concerned by many scholars, such as return contract [4,5], quantity flexibility (QF) contract [6][7][8][9], multiperiodic supply chain contracts [10][11][12], and risk-sharing contract [13,14]. ese flexibility contracts are widely applied in trade agreement for its flexibility and versatility.…”