Estimating the implied risk premium of U.S.-listed shipping firms

Abstract

ABSTRACTWhile the water transportation industry is perceived as risk-laden, expected return estimates for shipping firms, based on the capital asset pricing model (CAPM), are found to be ‘remarkably low.’ We apply the implied cost of capital (ICC), defined as the constant discount rate that equates share prices and future cash flows, as an alternative means of shipping expected returns and use these estimates instead, as well as in conjunction with the CAPM to provide fresh evidence on the risk and return characteristics of the shipping industry. An aggregate measure of ICC reveals that the median risk premium of shipping firms between 1983 and 2013 is in the range of 0.94% to 0.08%. The expected return of shipping firms tracks a long-term moving average of the S&P 500 index; nevertheless, shipping returns are below the index return at similar, and at times lower, levels with the 10-year treasury yield. The expected equity premium of the shipping industry implied in the cross-section of ICC estimates and CAPM betas ranges between 1.4% and 0.2%. The persistence of a ‘shipping return paradox’ against a variant of expected return methodologies may indicate the pricing of higher moments in the return distribution of shipping firms beyond the mean-variance framework.