Can you hedge ship price risk using freight derivatives? : a study of the dry bulk market

Abstract

This thesis investigates the possibility of reducing ship price risk in the dry bulk sector using freight derivatives. We establish a theoretical linkage between ship prices and FFA prices and empirically test this relationship. Based on this relationship, we construct a timeweighted FFA portfolio whose aim is to reflect the future operational earnings of a vessel. The static hedge ratios are calculated using the OLS model, while the dynamic hedge ratios are generated from a dynamic conditional correlation GARCH (1,1) model. We find that the hedging efficiency of an FFA portfolio on ship price risk is, in general, very good. However, there are variations among vessels of different vintages and sizes: (i) the hedging efficiency is negatively correlated with age; and (ii) the hedging efficiency is higher for the smaller vessel sizes. We also find that the static hedge ratio outperforms the dynamic hedge ratio in all ship categories. Thus, we conclude that an FFA portfolio can be used for ship price risk management in the dry bulk sector. Ship owners should apply a static hedging strategy and adjust the hedge ratio in accordance with the age and size composition of their fleets.