Risk hedging strategies on charterers' portfolio: the freight derivatives approach

Abstract

The shipping industry is the major player when it comes to carrying commodities across the globe. It is a capital-intensive industry, which involves a number of risks that can prove to be extremely dangerous for the market participants if not looked after properly. In the following study, we are showcasing the risks of shipping that the involved parties are facing and ways that said risks can be mitigated. We are presenting the history, use and importance of the freight rate derivatives contracts as risk mitigation tools. By gathering data for a 7-year time span of the most commonly used freight rate derivatives contracts of the wet bulk sector, we are testing a number of statistical models (namely the naïve method, MVHR, VECM, VECM GARCH) to determine the optimal hedge ratio required for risk minimization. Our methodology is based on studies carried out by researchers across various issues regarding the use of freight rate derivatives as risk hedging tools. The optimal hedge ratio calculation is performed from the perspective of the Charter, as the issues of fuel prices fluctuations, port costs etc. are not a part of the obligations that need to be fulfilled for the voyage execution. Our results suggest that using a fairly complicated model does not always lead to the higher variance reduction and, hence hedging effectiveness. Finally, we are tackling the issue of trading costs and their significance which if overlooked can lead to even the default of a counterparty; an issue that it is not studied extensively by researchers.