Pricing freight rate options

Steen Koekebakker (), Roar Adland and Sigbjørn Sødal

Transportation Research Part E: Logistics and Transportation Review, 2007, vol. 43, issue 5, 535-548

Abstract: In this paper we set up the theoretical framework for the valuation of the Asian-style options traded in the freight derivatives market. Assuming lognormal spot freight dynamics, we show that Forward Freight Agreements (FFA) are also lognormal prior to the settlement period, but that this lognormality subsequently breaks down. We suggest approximate dynamics in the settlement period for the FFA that leads to closed-form option pricing formulas for Asian call and put options written on the spot freight rate indices in the Black [Black, F., 1976. The pricing of commodity contracts. Journal of Financial Economics 3, 167-179] framework. In a Monte Carlo experiment we show that our formula gives very accurate prices, in particular for forward-starting freight options.

Keywords: Freight; rates; Bulk; shipping; Forward; freight; agreements; Options; Risk; management (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (23)

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