A non-parametric model of the timecharter-equivalent spot freight rate in the Very Large Crude oil Carrier market

The empirical research in this paper uses non-parametric techniques to avoid arbitrary parametric restrictions on the underlying freight rate process. The relevant hypotheses include: mean reverting freight rates in the bulk shipping industry due to continuous capacity adjustments (lay-up, scrapping, newbuilding), and increasing rate of change (volatility) in the freight rate level. The freight rate data are monthly averages from January 1989 to December 1998 in the Very Large Crude oil Carrier (VLCC) market. The empirical results indicate that the drift is non-linear with strong mean reversion only for high freight rates, and that the volatility is increasing progressively in the freight rate level. Moreover, the market price of freight rate risk is close to zero for low and medium freight rates and increasing in the freight rate level. The combined effect of the drift and market price of risk is strong mean reversion in a risk-neutral world. The introduction of a non-zero market price of risk has a large impact on the vessel valuation.