Freight derivatives pricing for decoupled mean-reverting diffusion and jumps. (December 2017)

• Record Type: Journal Article
• Authors: Kyriakou, Ioannis; Pouliasis, Panos K.; Papapostolou, Nikos C.; Andriosopoulos, Kostas
• Is Part Of: Transportation research. Volume 108(2017)
• Page Start: 80
• Page End: 96
• Publication Date: 2017-12
• Subjects: Uncertainty modelling -- Ocean freight -- Estimation -- Freight derivatives -- Pricing; Logistics -- Periodicals; Transportation -- Periodicals; 388.011
• DOI: 10.1016/j.tre.2017.09.002
• Languages: English
• ISSNs: 1366-5545

Abstract

Highlights: We propose an exponential decoupled mean-reverting jump diffusion model. We develop a valuation setup for arithmetic average options with discrete monitoring. The model is calibrated to Baltic option data. Jumps dissipate faster than the diffusive deviations about the equilibrium level. The model captures key features of the freight derivatives market. Abstract: We develop an accurate valuation setup for freight options, featuring an exponential mean-reverting 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.