Forecasting spot and forward prices in the international freight market

Abstract

This paper tests the performance of popular time series models in predicting spot and forward rates on major seaborne freight routes. Shipping is a nonstorable service, so the forward price is not tied to the spot by any arbitrage relationship. The developing forward market is dominated by hedgers, and it is an empirical question whether forward rates contain information about future spot rates. We find that vector equilibrium correction (VECM) models give the best in-sample fit, but implausibly suggest that forward rates converge strongly on spot rates. In out-of-sample forecasting all models easily outperform a random walk benchmark. Forward rates do help to forecast spot rates, suggesting some degree of speculative efficiency. However, in predicting forward rates, the VECM is unhelpful, and ARIMA or VAR models forecast better. The exercise illustrates the dangers of forecasting with equilibrium correction models when the underlying market structure is evolving, and coefficient estimates conflict with sensible priors.