Freight Futures Research Articles

Two New Strategies for Pricing Freight Options by Means of a Valuation PDE and by Functional Bounds

Freight derivative prices have been modeled assuming that the spot freight follows a particular stochastic process in order to manage them, like freight futures, forwards and options. However, an explicit formula for pricing freight options is not known, not even for simple spot freight processes. This is partly due to the fact that there is no valuation equation for pricing freight options. In this paper, we deal with this problem from two independent points of view. On the one hand, we provide a novel theoretical framework for pricing these Asian-style options. In this way, we build a partial differential equation whose solution is the freight option price obtained from stochastic delay differential equations. On the other hand, we prove lower and upper bounds for those freight options which enables us to estimate the option price. In this work, we consider that the spot freight rate follows a general stochastic diffusion process without restrictions in the drift and volatility functions. Finally, using recent data from the Baltic Exchange, we compare the described bounds with the freight option prices.

Shipping risk management practice revisited: A new portfolio approach

The international shipping industry is susceptible to heightened market volatility manifested in significant freight rate fluctuations and thus diversifying and hedging the associated risks have become central to shipping business practice. Building on the extant literature on shipping freight derivatives, this study develops a portfolio-based methodological framework aiming to improve freight rate risk management. The study also offers, for the first time, evidence of the hedging performance of the recently developed container freight futures market. Our approach utilises portfolios of container, dry bulk and tanker freight futures along with corresponding portfolios of physical freight rates in order to improve the efficacy of risk diversification for shipping market practitioners. The empirical findings uncovered in this study have important implications for overall business, commercial, and hedging strategies in the shipping industry, while they can ultimately lead to a more liquid and efficient freight futures market.

Freight Futures: The Potential Impact of Road Freight on Climate Policy

This paper describes changes to the modelling of the transport sector in the WITCH (World Induced Technical Change Hybrid) model to incorporate road freight and account for the intensity of freight with respect to GDP. Modelling freight demand based on the intensity of freight with respect to GDP allows for a focus on the importance of road freight with respect to the cost-effective achievement of climate policy targets. These climate policy targets are explored using different GDP pathways between 2005 and 2100, which are sourced from the Shared Socioeconomic Pathways (SSPs) database. Our modelling shows that the decarbonisation of the freight sector tends to occur in the second part of the century and the sector decarbonises by a lower extent than the rest of the economy. Decarbonising road freight on a global scale remains a challenge even when notable progress in biofuels and electric vehicles has been accounted for.

Economic information transmissions and liquidity between shipping markets: New evidence from freight derivatives

Economic return and volatility spillovers of derivatives markets on a number of assets have been extensively examined in the general economics literature. However, there are only a limited number of studies that investigate such interactions between freight rates and the freight futures, and no studies that also consider potential linkages with freight options. This study fills this gap by investigating the economic spillovers between time-charter rates, freight futures and freight options prices in the dry-bulk sector of the international shipping industry. Empirical results indicate the existence of significant information transmission in both returns and volatilities between the three related markets, which we attribute to varying trading activity and market liquidity. The results also point out that, consistent with theory, the freight futures market informationally leads the freight rate market, though surprisingly, freight options lag behind both futures and physical freight rates. The documented three-way economic interactions between the related markets can be used to enhance budget planning and risk management strategies, potentially attract more investors, and thus, improve the liquidity of the freight derivatives market.

Freight futures: The potential impact of road freight on climate policy

This paper describes changes to the modelling of the transport sector in the WITCH (World Induced Technical Change Hybrid) model to incorporate road freight and account for the intensity of freight with respect to GDP. Modelling freight demand based on the intensity of freight with respect to GDP allows for a focus on the importance of road freight with respect to the cost-effective achievement of climate policy targets. These climate policy targets are explored using different GDP pathways between 2005 and 2100, which are sourced from the Shared Socioeconomic Pathways (SSPs) database. Our modelling shows that the decarbonisation of the freight sector tends to occur in the second part of the century and that the sector decarbonises by a lower extent than the rest of the economy. Decarbonising road freight on a global scale remains a challenge even when notable progress in biofuels and electric vehicles has been accounted for.

Economic Information Transmissions between Shipping Markets: New Evidence from Freight Derivatives Markets

Economic return and volatility spillovers of derivatives markets on a number of assets have been extensively examined in the general economics literature. However, there are only a limited number of studies that investigate such interactions between freight rates and the freight futures, and no studies that also consider potential linkages with freight options. This study fills this gap by investigating the economic spillovers between time-charter rates, freight futures and freight options prices in the dry-bulk sector of the international shipping industry. Empirical results indicate the existence of significant information transmission in both returns and volatilities between the three related markets, which we attribute to varying trading activity and market liquidity. The results also point out that, consistent with theory, the freight futures market informationally leads the freight rate market, though surprisingly, freight options lag behind both futures and physical freight rates, thus not fulfilling their price discovery function. The documented three-way economic interactions between the related markets can be used to enhance budget planning and risk management strategies, potentially attract more investors, and thus, improve the liquidity of the freight derivatives market.

Are Freight Futures Markets Efficient? Evidence from IMAREX

The International Maritime Exchange (IMAREX) is the leading regulated marketplace for trading and clearing shipping freight derivatives. We investigate for the first time whether the IMAREX freight futures market is efficient over daily and weekly horizons. To this end, we address the question in both a statistical and an economic setting by employing an extensive dataset of freight futures prices. In the statistical setting, we form both point and interval forecasts by alternative models and evaluate them using a number of statistical tests. We assess the economic significance of the obtained forecasts by means of trading strategies and taking into account the presence of transactions costs. We find that IMAREX is not efficient over the shorter daily horizon. The results have implications for the economics of freight futures markets and pricing of freight derivatives.

The Beginnings of National e-Freight Portals in Australia, Asia and Europe

In late 2008 the State of Victoria, in Australia, released 'Freight Futures: The Victorian Freight Network Strategy' (DoT, 2008). This was the first major Australian State Freight Strategy that recommended the implementation of an information communication technology (ICT) public domain portal that would enable small and medium enterprises (SMEs) within the freight transport sector to achieve higher levels of productivity and efficiency through access to, and use of, an internet based e-freight portal, utilising software-as-a-service (SaaS) applications. This was a planning initiative that may be seen as a next step compared to the Tsinghua University e-freight software applications that were listed on a 'public domain' marketplace, or even wider in application than the Port community efreight portals that Singapore and other major ports have already built. Efficiencies for the target user groups using these e-freight applications are identified as delivering significant productivity benefits to the user communities.

Pricing and hedging in the freight futures market

In this article, we consider the pricing and hedging of single-route dry bulk freight futures contracts traded on the International Maritime Exchange. Thus far, this relatively young market has received almost no academic attention. In contrast to many other commodity markets, freight services are non-storable, making a simple cost-of-carry valuation impossible. We empirically compare the pricing and hedging accuracy of a variety of continuous-time futures pricing models. Our results show that the inclusion of a second stochastic factor significantly improves the pricing and hedging accuracy. Overall, the results indicate that the Schwartz and Smith (2000) two-factor model provides the best performance. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark 31:440–464, 2011

Are freight futures markets efficient? Evidence from IMAREX

Abstract The International Maritime Exchange (IMAREX) is the leading regulated marketplace for trading and clearing shipping freight derivatives. We investigate for the first time whether the IMAREX freight futures market is efficient over the daily and weekly horizons. To this end, we address the question in both a statistical setting and an economic setting by employing an extensive dataset of freight futures prices. In the statistical setting, we form both point and interval forecasts using alternative models, and evaluate them using a number of statistical tests. We assess the economic significance of the obtained forecasts by means of trading strategies, taking into account the presence of transactions costs. We find that IMAREX is not efficient over the shorter daily horizon. The results have implications for the economics of freight futures markets and the pricing of freight derivatives.

Pricing and Hedging in the Freight Futures Market

In this article, we consider the pricing and hedging of single route dry bulk freight futures contracts traded on the International Maritime Exchange. Thus far, this relatively young market has received almost no academic attention. In contrast to many other commodity markets, freight services are non-storable, making a simple cost-of-carry valuation impossible. We empirically compare the pricing and hedging accuracy of a variety of continuous-time futures pricing models. Our results show that the inclusion of a second stochastic factor significantly improves the pricing and hedging accuracy. Overall, the results indicate that the Schwartz and Smith (2000) two-factor model provides the best performance.

Integration and Causality in International Freight Markets: Modeling with Error Correction and Directed Acyclic Graphs

Using directed acyclic graphs (DAGs) and error correction models, we study the dynamics of freight prices that comprise the Baltic Panamax Index (BPI), the index on which freight futures trading was based. The DAGs are used to make statements about the contemporaneous correlations between prices and allow us to address the construction of the data‐determined orthogonalization on contemporaneous innovation covariance, which is crucial in providing inference in innovation accounting techniques. Our results provide a source of information on price discovery and suggest that the index is not appropriately composed and weighted, which may help explain the failure of the Baltic International Freight Futures Exchange (BIFFEX) contract.

Integration and Causality in International Freight Markets: Modeling with Error Correction and Directed Acyclic Graphs

1. IntroductionIn January 1985, the Baltic Exchange developed the then known Baltic Freight Index (BFI), which, in May 1985, would become the underlying asset of the Baltic International Freight Futures Exchange (BIFFEX) contract, a contract designed to hedge uncertainty associated with volatile freight rates. On the basis of their exposure to the risk of adverse freight-rate fluctuations, ship owners and cargo owners (charterers) could buy or sell BIFFEX contracts to protect their freight-rate revenue or control their freight-rate cost, respectively. In addition to its once use for futures trading, the BFI is also considered to be the leading indicator of the condition in the dry-bulk shipping markets. On a daily basis, it provides accurate information about the level of freight rates across a variety of shipping routes worldwide. This information is extremely valuable for shipping market agents and is an invaluable tool in their decision-making process. This is so because in an industry such as shipping, where trades are being concluded across the globe, there is not a central reporting place to record and monitor the level of activity in the markets.The principal objective of this article is to assess the degree of interconnectivity between the major shipping routes that constitute the BFI, across different time horizons, reflecting the typical trading patterns in this market. To this end, we employ directed acyclic graphs (DAGs) (Spirtes, Glymour, and Scheines 1993), which enable us to assess this issue in a dynamic manner. Based on an error correction model (ECM) of freight rates, we also develop a framework for estimating forecast error decompositions by employing DAGs. From a practical standpoint, the information provided by innovation accounting techniques, coupled with DAG analysis, provides an intuitive method for assessing the information flows from the shipping markets and allows us to make an assessment on whether the underlying freight index, on which the futures contract is traded, is correctly composed.The current article, therefore, makes significant contributions to the literature from several angles. To date, research has not estimated the relationships in a truly dynamic manner and has, as such, failed to discuss the implications for derivatives and physical trading. In addition, the application of innovation accounting in this study is different from most other studies in the sense that we use the causal ordering of variables, as indicated by the estimated DAGs, for the orthogonalization of the contemporaneous innovation covariance; as suggested by Swanson and Granger (1997), this step is crucial in providing sound inference in innovation accounting techniques. Finally, investigation of this issue has important implications for the purposes of futures trading, as the BIFFEX contract was eventually delisted in April 2002. In this article, we identify whether the index is correctly composed and whether there are any obvious patterns or redundancies within the index that may have led to the demise of the futures contract. Indeed, our analysis provides a mechanism for deciding upon the correct index and has obvious, yet profound, implications for other research in the area of index construction.The rest of the article is as follows. Section 2 offers a brief discussion of freight indices. Section 3 outlines the methodologies employed in the article, including an introduction to DAGs, and section 4 describes the underlying properties of the data series. Section 5 presents the empirical results, and section 6 concludes.2. Freight Indices and Freight FuturesGiven uncertainty surrounding freight rates, the benefits of providing a futures market in freight rates has been recognized by market practitioners for a long time. However, the freight futures market was eventually established only in 1985. The reason is that the underlying asset of the market--the service of seaborne transportation--is not a physical commodity that can be delivered at the expiry of the futures contract. …

Price Discovery, Causality and Forecasting in the Freight Futures Market

This paper investigates the causal relationship between futures and spot prices in the freight futures market. Being a thinly traded market whose underlying asset is a service, sets it apart from other markets investigated so far in the literature. Causality tests, generalised impulse response analysis and forecasting performance evaluation indicate that futures prices tend to discover new information more rapidly than spot prices. Revisions in the composition of the underlying index to make it more homogeneous, have strengthened the price discovery role of futures prices. The information incorporated in futures prices, when formulated as a VECM, produces more accurate forecasts of spot prices than the VAR, ARIMA and random-walk models, over several steps ahead.

Tanker forward freight agreements: the future for freight futures?

Since paper freight-hedging tools were introduced to counter volatile tanker freight rates, the hesitant uptake of tanker Forward Freight Agreements (FFAs) has been attributed to traditional risk seeking propensities amongst tanker owners, naturally reluctant to hedge against risk. To test how far the well-documented generic determinants and incentives for corporate hedging could explain this hesitation in the tanker market, the attitudes of tanker owners and charterers towards freight hedging, risk and perceptions of FFAs, were surveyed. Although FFAs were widely viewed as an important development, some respondents were unaware of their function and a majority had not used them. The link between freight hedging activity and participants' risk aversion was not clear-cut, but with market liquidity critical to raising FFA usage improved technical education is essential to widespread acceptance

Hedging foreign currency, freight, and commodity futures portfolios—A note

AbstractForeign exchange hedging ratios are simultaneously estimated alongside freight and commodity ratios in a time‐varying portfolio framework. Foreign exchange futures are by far the most important derivative instrument used to reduce uncertainty for traders. Our results lend support to the decision by the London International Financial Futures Exchange to cease trading the Baltic International Freight Futures Exchange freight futures contract because of its low levels of trading activity that likely resulted from its apparent unattractiveness as a hedging instrument. @ 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:1205–1221, 2002

The effect of barge and ocean freight price volatility in international grain markets

This paper looks at the potential role of time-varying volatility of Mississippi river barge and ocean freight prices on commodity prices in Illinois, at the US Gulf and in Rotterdam using a Vector Error Correction GARCH-in-Mean model. The model is used to infer the extent to which transportation price risk affects price dynamics in international grain markets. Results from a simulation exercise indicate that both barge and ocean price volatility influence grain prices, but barge price volatility tends to have a greater impact on grain prices and marketing margins than that arising from ocean price volatility. Consistent with most studies that evaluate the role of risk in marketing channels, results here suggest that a reduction in barge rate risk would reduce marketing margins between Illinois and the US Gulf, and between the US Gulf and Rotterdam. The existence of an ocean freight futures contract coupled with the lack of a futures contract for barge rates may be partially responsible for the finding that barge rates have a significant influence on grain prices and contribute most to wide marketing margins found throughout the international grain-marketing system.

Price Discovery, Causality and Forecasting in the Freight Futures Market

This paper investigates the causal relationship between futures and spot prices in the freight futures market. Being a thinly traded market whose underlying asset is a service, sets it apart from other markets investigated so far in the literature. Causality tests, generalised impulse response analysis and forecasting performance evaluation indicate that futures prices tend to discover new information more rapidly than spot prices, which is in line with the empirical evidence from other markets. Sub-period results, corresponding to revisions in the composition of the underlying index, show that the price discovery role of futures prices has strengthened as a result of the more homogeneous composition of the index in the recent years. This also indicates that the restructuring of the underlying index in November 1999, to reflect trade flows which are homogeneous in terms of commodities and cargo sizes, may have a beneficial impact on the market. Finally, the information incorporated into futures prices, when formulated as a VECM, produces more accurate forecasts of the spot prices than the VAR, ARIMA and random-walk models, over several steps ahead.

Hedging Multiple Price Uncertainty in International Grain Trade

AbstractCommodity and freight futures contracts are analyzed for their effectiveness in reducing uncertainty for international traders. A theoretical model is developed for a trader exposed to several types of risk. OLS hedge ratio estimation is compared to the SUR and the multivariate GARCH methodologies. Explicit modeling of the time‐variation in hedge ratios via the multivariate GARCH methodology, using all derivatives, and taking into account dependencies between prices, results in reductions in risk, even after accounting for transaction costs. Results confirm that while the commodity futures contracts are important for hedging risk, freight futures are a useful mechanism for reducing risk.

Hedging in the Freight Futures Market

Price risks are everywhere, and a profusion of derivative instruments have been created to hedge them. The BIFFEX Baltic Freight Index futures contract, based on an index of ocean shipping costs for a set of standard routes, is one of the more unusual. An important problem with such a futures contract based on a nonstorable service is that there is no arbitrage trade to enforce cost of carry pricing. This allows considerable basis risk in the contract. In this article, Kavussanos and Nomikos examine the hedging characteristics of the BIFFEX contract within a GARCH framework that takes account of cointegration between the spot and futures markets. They find that allowing for time variation in the hedge ratio does improve hedge performance, but basis risk remains very large compared with other futures markets. A recent change in the contract, to use a narrower index, appears to have reduced the problem somewhat, but not enough to produce much increase in trading activity so far.