Forward Freight Agreements And Their Application To The Tanker Freight Market

The international dirty tanker freight market is an important part of theworld shipping market, which transports crude oil from producer regions toconsumer regions. The dirty tanker freight market experienced a history ofhuge fluctuations and higher risks due to the imbalance of demand andsupply of transport capacity, relevant markets, political events and naturefactors. The volatilities in the dirty tanker freight rates are harmful toparticipants and they always want to hedge the freight rate risks by variousmethods.Generally speaking, split operations of the fleet, floating-index methodand long-term charter contracts are used to hedge the freight rate risks.However, these methods are not flexible and cannot meet participants’ needs.Referring to financial derivatives markets, some shipping derivatives, such as forward freight agreement (FFA), freight future and freight option, areprovided to participants to hedge the freight rate risks. FFA is the mostwidely used among all the shipping derivatives. Therefore, this paper is aimto investigate the unbiasedness hypothesis, spillover effects and hedgingfunction in the dirty tanker FFA market. Some practical suggestions may beprovided according to the empirical results of this research.In this paper, a vector error correction model is employed to test theunbiasedness hypothesis, multivariate GARCH models are used toinvestigate the spillover effects between different tanker markets and thetime-varying hedge ratio is calculated based on copula method in order tominimize the value at risk.Empirical results from this study are as follows. First, significantlypositive impacts of the crude oil supply shocks on the dirty tanker freightlevels are found. However, the impacts of crude oil non-supply shocks areinsignificant. Second, we find no evidence of unbiasedness existing in thesample FFA contracts, which increases the hedge cost and influencesparticipants’ decisions. Third, volatility spillover effects among one-monthFFA, two-month FFA and spot tanker freight markets are bilateral. Spillovereffects in returns are unilateral from one-month FFA market to spot tankerfreight market while they are bilateral between one-month FFA and two-month FFA markets. Finally, the optimal hedge ratio is calculated basedon copula method in order to minimize the value at risk. The hedge ratios cannot only reflect the dependence between the spot and forward tanker markets,but also can describe the contributions of diversified investments to riskdecrease.