Do Nonlinear Tools Make a Difference in Handling Shipping Derivatives

Abstract

In time series analysis, especially in non-linear time series, a school appeared after 1963. The classical school argued share price variations obey the normal distribution law and are random, in which case observations are identically distributed and independent. Although Brown (1828), Bachelier (1900), and Einstein (1905) created the background, the well-known AR(IMA) models were invented by Yule (1927). The modern school argued that time series appear to be random with a behavior under determinism, are subject to power law, and have a long run memory. Recent (nonlinear) work has not related to shipping freight derivatives, but to ship prices and freight markets. Derivatives are known as a shipping risk management means. According to the classical theory, derivative value should relate to volatility and reward, and volatility relates to standard deviation, provided the randomness of freight rates, for freight market risk management. That, to the shipping industry and its bankers, risk management is an alien concept, was written about by Stokes (1997). Stokes likened the typical shipowner to a speculator or a gambler who enjoys making large bets, and, in the hope of winning an enormous prize, risks liberal amounts of money. The authors' personal experience is that Greek shipowners, at least, are conservative. There are times when it is true, however, that in a three-year (ship) operation, more money comes from a single asset's sale than its use. Both tremendous failures and unbelievable fortunes have been created by the shipping industry, and the bankers pick up the pieces at day's end. People are attracted to the industry by massive successes, such as those seen in recent years, and repelled by failures. That risk must be managed is of no doubt, for it certainly exists. Understanding relevant market natures allow this best to be achieved. The authors demonstrate that shipping freight derivatives are persistent, while freight markets are anti-persistent, rather than random. Interaction between two opposing forces seems to occur through this phenomenon. Shipping freight market analysis must be done in a general finance context. Mandelbrot-Hudson (2004) approach applications suggests that a catastrophe's real chances of happening range between 1/10 and 1/30, or, in other words, it is much greater than what would be indicated by random walk.