TCPOP : Valuation and Optimal Strategy for Option Contracts in the Shipping Industry

Abstract

This thesis is an analysis of a special type of option contract often found in the shipping industry, a time charter with purchase option (TCPOP). The TCPOP is a time charter (TC) agreement with an embedded purchase option. The freight rate is modeled using the two mean reverting stochastic pro- cesses: Ornstein Uhlenbeck (OU) and Geometric Mean Reversion (GMR). Both models are estimated from historical spot freight rate data on Suezmax tankers, using OLS. Based on the stochastic processes I specify a one factor model for vessel values. The model is calibrated to historical prices for 5 year old vessels, by approximating the risk premium, using a numerical least squares method. GMR seems to perform better than OU in predicting the distribution of future freight rates and vessel values. Using Monte Carlo simulation and applying the least square Monte Carlo approach (LSM) proposed by Longsta & Schwartz (2001), I specify proce- dures for approximating values of option contracts with di erent complexity, where a Suezmax vessel is the underlying asset. GMR consistently predicts higher vessel values and option values than OU.