Estimating risk‐neutral freight rate dynamics: A nonparametric approach

Abstract

AbstractWe present a new method for estimating the unobservable drift of the risk‐neutral spot freight rate process from Forward Freight Agreements (FFA) prices in the absence of a closed‐form solution and demonstrate robustness via numerical simulations. Moreover, we conduct empirical experiments involving estimation of standard parametric models and a nonparametric model using Baltic Exchange data. We find that our nonparametric approach yields the lowest FFA pricing errors across maturities. Finally, we estimate the market price of risk, analyze its behavior in‐sample and out‐of‐sample and observe that, when estimated using our nonparametric approach, it evolves consistently with the indices under study.