A structural linkage model for freight rates

ABSTRACT This paper examines the role of Capesize vessels in freight markets by proposing a continuous-time freight rate model based on functional supply-and-demand curves, which is referred to as "a structural linkage model for freight rates". The model incorporates market participant trading behavior in the sense that high Capesize prices induce shipowners and charterers to switch from Capesize to Panamax vessels, resulting in a rise in Panamax demand and a high Capesize-Panamax price correlation, while high Panamax prices tend to cause the freight market participants to switch from Panamax to much smaller ships, resulting in a fall in Panamax demand and a low Capesize-Panamax price correlation. The model can also represent both the positive and negative relationships between the freight prices and the volatilities of the freight prices, which are referred to as the "inverse leverage effect" and the "leverage effect", respectively. An empirical study estimates the model parameters using the Capesize and Panamax rates for fronthaul routes given by the Baltic Exchange in the recent upward trend periods. We demonstrate that Panamax demand increases in line with Capesize prices and decreases in line with Panamax prices, resulting in high and low Capesize-Panamax price correlations, respectively, which is consistent with the model we propose. This finding may imply that Capesize vessels play an important role in the other freight markets, including Panamax markets. Finally, we empirically show both the inverse leverage and leverage effects in freight markets often observed in energy and security markets, respectively.