Static Hedging of Freight Rate Risk in the Shipping Market under Model Uncertainty

TL;DR

This paper develops a robust framework for hedging freight rate risk in shipping markets under model uncertainty, utilizing Wasserstein barycenters to improve the stability of hedging strategies amid economic shocks.

Contribution

It introduces a novel approach combining Wasserstein barycenters with freight rate modeling to enhance robust hedging strategies under uncertainty.

Findings

Effective approximation of optimal hedging strategies in high noise scenarios.

Robustness of the proposed method against market uncertainties.

Improved stability of freight risk management strategies.

Abstract

Freight rate derivatives constitute a very popular financial tool in shipping industry, that allows to the market participants and the individuals operating in the field, to reassure their financial positions against the risk occurred by the volatility of the freight rates. The special structure of the shipping market attracted the interest of both academics and practitioners, since pricing of the related traded options which are written on non-storable assets (i.e. the freight service) is not a trivial task. Management of freight risk is of major importance to preserve the viability of shipping operations, especially in periods where shocks appear in the world economy, which introduces uncertainty in the freight rate prices. In practice, the reduction of freight risk is almost exclusively performed by constructing hedging portfolios relying on freight rate options. These portfolios needs to be robust to the market uncertainties, i.e. to choose the portfolio which returns will be as less as it gets affected by the market changes. Especially, for time periods where the future states of the market (even in short term) are extremely ambiguous, i.e. there are a number of different scenarios that can occur, it is of great importance for the firms to decide robustly to these uncertainties. In this work, a framework for the robust treatment of model uncertainty in (a) modeling the freight rates dynamics employing the notion of Wasserstein barycenter and (b) in choosing the optimal hedging strategy for freight risk management, is proposed. A carefully designed simulation study in the discussed hedging problem, employing standard modelling approaches in freight rates literature, illustrates the capabilities of the proposed method with very satisfactory results in approximating the optimal strategy even in high noise cases.