Can shipping freight rate risk be reduced using forward freight agreements?

Abstract

This thesis investigates the forecasting performance and hedge efficiency of 50 Forward Freight Agreements (FFA) in bulk shipping from 2005 to 2012. We find that the hedge ratios estimated with the conventional method offer high hedge efficiency for the majority of the FFAs in the in-sample period. By holding these hedge ratios through an out-of-sample period, we find that the hedge efficiency is not robust for the majority of the contracts. This is likely due to time varying covariance between freight rate returns and FFA returns, in addition to changing variance in FFA returns. Our findings suggests that the conventional method of calculating optimal hedge ratios does not outperform a naive hedge. Furthermore, we find that FFA prices are unbiased predictors of subsequent spot freight rates in 42 of 50 contracts across the four segments. However, they are only stable predictors when we consider current- and one-month contracts. The forecasting performance decreases when the forecasting horizon increases. The basis provides unbiased forecasts of subsequent freight rate change in 42 of the 50 contracts. It does not provide stable forecasts in the Capesize and Panamax segments. The forecasting power of the basis in the Clean and Dirty tanker markets are medium, and increases with the forecasting horizon. The basis on five month contracts written on TC5 and TD5 is relatively high with R2 at 0.65 and 0.58, respectively.