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Simulating physical basis risks in the Capesize freight market

Author

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  • Roar Adland

    (Norwegian School of Economics)

  • Haiying Jia

    (Center for Applied Research (SNF))

Abstract

The purpose of this paper is to evaluate the characteristics of the time-varying differential between the Baltic global trip-charter average and simulated earnings from a fleet of Capesize vessels. We interpret the standard deviation of this differential as a measure of physical basis risk in freight market hedging, resulting from differences in assumed trading patterns and the sequential fixing of vessels at different regional rates around the world. We simulate the average earnings of a fleet over time by sequentially assigning vessels to any of the four main trading routes (trans-Atlantic, trans-Pacific, fronthaul and backhaul) with a conditional probability based on known historical commodity flows. We show that increasing the fleet size lowers the basis risk but that this diversification effect is low beyond a relatively small fleet size of about 10 ships. Furthermore, we show that this physical basis risk never disappears, even for a very large fleet, due to a moving-average effect in earnings. Finally, we illustrate that physical basis risk is greater for short hedging durations. The results are important for shipowners and operators in the design of cost-efficient hedging programmes and for the Baltic Exchange and its stakeholders engaged in the continuous improvement of the quality of its spot rate indices.

Suggested Citation

  • Roar Adland & Haiying Jia, 2017. "Simulating physical basis risks in the Capesize freight market," Maritime Economics & Logistics, Palgrave Macmillan;International Association of Maritime Economists (IAME), vol. 19(2), pages 196-210, June.
    • Handle: RePEc:pal:marecl:v:19:y:2017:i:2:d:10.1057_s41278-016-0053-5
    DOI: 10.1057/s41278-016-0053-5
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    References listed on IDEAS

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    Cited by:

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    2. Prochazka, Vit & Adland, Roar & Wallace, Stein W., 2019. "The value of foresight in the drybulk freight market," Transportation Research Part A: Policy and Practice, Elsevier, vol. 129(C), pages 232-245.
    3. Regli, Frederik & Adland, Roar, 2019. "Crude oil contango arbitrage and the floating storage decision," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 122(C), pages 100-118.
    4. Yang, Jialin & Ge, Ying-En & Li, Kevin X., 2022. "Measuring volatility spillover effects in dry bulk shipping market," Transport Policy, Elsevier, vol. 125(C), pages 37-47.
    5. Sun, Xiaolin & Haralambides, Hercules & Liu, Hailong, 2019. "Dynamic spillover effects among derivative markets in tanker shipping," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 122(C), pages 384-409.
    6. Adland, Roar & Prochazka, Vit, 2021. "The value of timecharter optionality in the drybulk market," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 145(C).
    7. Bai, Xiwen & Cheng, Liangqi & Iris, Çağatay, 2022. "Data-driven financial and operational risk management: Empirical evidence from the global tramp shipping industry," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 158(C).
    8. Gong, Yuting & Li, Kevin X. & Chen, Shu-Ling & Shi, Wenming, 2020. "Contagion risk between the shipping freight and stock markets: Evidence from the recent US-China trade war," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 136(C).
    9. Alexandridis, George & Sahoo, Satya & Song, Dong-Wook & Visvikis, Ilias, 2018. "Shipping risk management practice revisited: A new portfolio approach," Transportation Research Part A: Policy and Practice, Elsevier, vol. 110(C), pages 274-290.
    10. Roar Adland & Haakon Ameln & Eirik A. Børnes, 2020. "Hedging ship price risk using freight derivatives in the drybulk market," Journal of Shipping and Trade, Springer, vol. 5(1), pages 1-18, December.
    11. Adland, Roar & Alizadeh, Amir H., 2018. "Explaining price differences between physical and derivative freight contracts," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 118(C), pages 20-33.

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