Hedging in the Freight Futures Market

Posted: 18 Feb 2014

See all articles by Nikos K. Nomikos

Nikos K. Nomikos

Cass Business School, City University London

Manolis G. Kavussanos

Athens University of Economics and Business - Department of Accounting and Finance

Date Written: 2000

Abstract

Time-varying hedge ratios have been found successful in reducing spot market risk in different commodity and financial futures markets. This article extends the empirical evidence by investigating the same question for a futures market based on services, the Baltic International Freight Futures Exchange (BIFFEX) market. BIFFEX contracts are cash settled against the Baltic Freight Index (BFI), a weighted average dry-cargo freight rate index, compiled from actual freight rates on 11 shipping routes which are dissimilar in terms of vessel sizes and transported commodities.

GARCH and augmented GARCH models are introduced to investigate the hedging effectiveness of the futures contract across the different shipping routes. Time-varying hedge ratios outperform alternative specifications in reducing market risk, in four shipping routes, but they fail to reduce the riskiness of the spot position, to the extent found for other markets in the literature. This is explained by the fact that freight futures contracts are employed as a cross-hedge against the fluctuations of the individual shipping routes that constitute the underlying index. There is large basis risk, and the rate fluctuations on these routes may not be accurately tracked by the futures prices.

A recent change in the contract’s underlying index appears to have substantially increased hedging effectiveness, but not trading activity as yet.

Suggested Citation

Nomikos, Nikos K. and Kavussanos, Manolis G., Hedging in the Freight Futures Market (2000). Journal of Derivatives, Vol. Fall, No. 2000, pp. 41 - 58. Available at SSRN: https://ssrn.com/abstract=1435278

Nikos K. Nomikos

Cass Business School, City University London ( email )

London, EC2Y 8HB
Great Britain

Manolis G. Kavussanos (Contact Author)

Athens University of Economics and Business - Department of Accounting and Finance ( email )

76 Patission St
TK 104 34 Athens
Greece
0030 210 8203167 (Phone)
0030 210 8228816 (Fax)

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