Explaining price differences between physical and derivative freight contracts.

Highlights • The time-varying differential between physical and derivatives freight rates is examined. • The physical freight rates tend to be statistically at a premium to Forward Freight Rates. • Differential is related to the market conditions, vessel specific factors and contractual terms. • The premium of physical freight over forward rates is due to convenience of access to transport. Abstract Physical time-charters (TC) and Forward Freight Agreements (FFAs) represent two hedging approaches that differ in terms of risks and physical access to transportation. We investigate the determinants of the time-varying TC-FFA freight rate differential in the dry bulk market. We find that TC and FFA prices are co-integrated but TC rates are generally priced higher than FFAs. The differential is explained by the level and slope of the term structure, a measure of economic condition and default risk as well as vessel specifications and contractual terms. Finally, the TC-FFA differential is related to default risk premium and the potential convenience yield. [ABSTRACT FROM AUTHOR]