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Market switching in shipping -- A real option model applied to the valuation of combination carriers

Listed author(s):
  • Sødal, Sigbjørn
  • Koekebakker, Steen
  • Aadland, Roar

This paper derives a real options model of flexibility and applies it to shipping, valuing the option to switch between the dry bulk market and wet bulk market for a combination carrier, a ship type that is capable of operating in both markets but that has fallen out of favor due to high price tags. The model is a mean-reverting (Ornstein-Uhlenbeck) version of a standard entry-exit model with stochastic prices. A closed form solution for the value of flexibility is derived, expressed in terms of Kummer functions. The estimated value of flexibility is related to historical price differentials between combination carriers and oil tankers of comparable size. Based on numerical experiments it is concluded that new combination carriers may enter the market in the near future.

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File URL: http://www.sciencedirect.com/science/article/pii/S1058-3300(07)00027-4
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Article provided by Elsevier in its journal Review of Financial Economics.

Volume (Year): 17 (2008)
Issue (Month): 3 (August)
Pages: 183-203

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Handle: RePEc:eee:revfin:v:17:y:2008:i:3:p:183-203
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/620170

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  1. Bar-Ilan, Avner & Strange, William C, 1996. "Investment Lags," American Economic Review, American Economic Association, vol. 86(3), pages 610-622, June.
  2. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-638, June.
  3. Perron, Pierre & Rodriguez, Gabriel, 2003. "GLS detrending, efficient unit root tests and structural change," Journal of Econometrics, Elsevier, vol. 115(1), pages 1-27, July.
  4. Steen Koekebakker & Roar Adland & Sigbjørn Sødal, 2006. "Are Spot Freight Rates Stationary?," Journal of Transport Economics and Policy, University of Bath, vol. 40(3), pages 449-472, September.
  5. Serena Ng & Pierre Perron, 2001. "LAG Length Selection and the Construction of Unit Root Tests with Good Size and Power," Econometrica, Econometric Society, vol. 69(6), pages 1519-1554, November.
  6. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
  7. Duan, Jin-Chuan & Pliska, Stanley R., 2004. "Option valuation with co-integrated asset prices," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 727-754, January.
  8. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-157, April.
  9. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 707-727.
  10. Alberto Moel, 2002. "When Are Real Options Exercised? An Empirical Study of Mine Closings," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 35-64, March.
  11. Jostein Tvedt, 2003. "Shipping market models and the specification of freight rate processes," Maritime Economics & Logistics, Palgrave Macmillan;International Association of Maritime Economists (IAME), vol. 5(4), pages 327-346, December.
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