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Freight Derivatives Pricing for Decoupled Mean-Reverting Diffusion and Jumps

Kyriakou, I., Pouliasis, P. K., Papapostolou, N. C. and Andriosopoulos, K. (2017). Freight Derivatives Pricing for Decoupled Mean-Reverting Diffusion and Jumps. Transportation Research Part E: Logistics and Transportation Review, 108, pp. 80-96. doi: 10.1016/j.tre.2017.09.002

Abstract

We develop an accurate valuation setup for freight options, featuring an exponential meanreverting 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.

Publication Type: Article
Additional Information: © 2017. This manuscript version is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/
Publisher Keywords: uncertainty modelling; ocean freight; estimation; freight derivatives; pricing
Subjects: H Social Sciences > HG Finance
Q Science > QA Mathematics
Departments: Cass Business School > Finance
School of Mathematics, Computer Science & Engineering > Engineering
URI: http://openaccess.city.ac.uk/id/eprint/18168
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