Freight Derivatives Pricing for Decoupled Mean-Reverting Diffusion and Jumps
Transportation Research Part E: Logistics and Transportation Review, 2017, 108, 80-96
34 Pages Posted: 20 May 2017 Last revised: 16 Feb 2019
Date Written: May 19, 2017
Abstract
We develop an accurate valuation setup for freight options, featuring an exponential mean-reverting model for the freight rate with distinct reversion scales for its jump and diffusion components. We calibrate to Baltic option prices and analyze the freight rate dynamics. More specifically, we observe that jumps dissipate faster than the diffusive deviations about the equilibrium level. We benchmark against practitioners’ model of choice, i.e., the lognormal model, and variants, and find that our approach reduces the pricing error while preserving analytical tractability and computational competence. We also find that neglecting fast mean-reverting jumps leads to nontrivial option mispricings.
Keywords: uncertainty modelling, ocean freight, estimation, freight derivatives, pricing
JEL Classification: C13, C63, G13
Suggested Citation: Suggested Citation