An analysis of entry and exit decisions in shipping markets under uncertainty

Abstract

Objective: The existing literature on the application of real options in maritime economics is rather limited. Bendall & Stent (2003, 2005, 2007 show how investing in a new ship or maritime technology can incorporate an option value. Another application is elaborated by Bjerksund & Ekern (1995), discussing the value of mean-reverting cash flows through contingent claim analysis, applied to time charters. The analysis of the entry and exit decision in the shipping markets can form an interesting extension of this research. Shipping markets are in nature uncertain and cyclical (Stopford, 2009). For this reason, the real options based model of Ruiz-Aliseda & Wu (2012) for stochastically cyclical markets will be applied to the shipping markets, in order to define entry and exit thresholds in this market.Data/Methodology: Data on the freight rates, costs and ship prices are used for estimating the parameters present in the real options based model of Ruiz-Aliseda & Wu (2012) for stochastically cyclical markets. This model incorporates a discrete-time Markov process, an alternative for the traditionally used geometric Brownian motion (GBM) and suited to model the cyclicality of the shipping markets. Investing in a ship and selling it again can respectively be interpreted as entering and exiting the market. Hence, the model can be applied here in order to predict the optimal values for entry and exit in the shipping markets.Results/Findings: The theoretically calculated results will be tested on real cases using data on container time charter prices over different periods, to see how well the theoretically developed model performs in the shipping markets. In that way, the estimation of parameters and the assumptions of the model can be evaluated on their accuracy in these cyclical markets.Implications for Research/Policy: In the first place, this case study can indicate how well the model performs in another market. If the model turns out to successfully predict market entry and exit thresholds, it could help companies to make better predictions on competitor behaviour. Also for policy makers, it could help to have a more accurate insight in the required capacity for ports.

Investment into container shipping capacity: A real options approach in oligopolistic competition

“…The random shock term is governed by a geometric Brownian motion (drift, interest rate, and volatility are detailed in Table 1); this is in line with previous shipping industry-related work by Adland and Cullinane (2006), Adland and Strandenes (2007), Bendall andStent (2005, 2007), Goncalves (1992), Koekebakker et al (2007), Sødal et al (2008), and Gkochari (2015). Possible alternatives are geometric mean reversion (Tvedt, 1997(Tvedt, , 2003, the Ornstein-Uhlenbeck process (Bjerksund and Ekern, 1995), or the assumption of stochastically cyclical markets (Balliauw, 2015;Ruiz-Aliseda and Wu, 2012). Note that a positive drift in the GBM is an assumption from a long-term perspective; a full calibration to the past five years of freight or time charter rates could also justify a 0% drift assumption.…”

“…Ruiz-Aliseda and Wu (2012) model entry and exit decisions in cyclical markets and show how entry and exit patters are different from those obtained by the assumption of a geometric Brownian motion. An application of this model to the shipping context can be found in Balliauw (2015).…”

A survey of shipping finance research: Setting the future research agenda

“…• Momentum strategies perform better than contrarian (buy-and-hold) strategies • Higher degree of participation of momentum (contrarian) investors can lead to increase (decrease) in the volatility of second-hand ship prices Balliauw (2017) Utilises real options model to analyse the buy (entry) and sell (exit) decisions of container shipowners…”

“…They find that the number of market participants and the intensity of competition affect optimal capacity, company values and investments. Focusing on the container market and adopting a Markov process, Balliauw (2017) uses a real options model, to analyse the buy (entry) and sell (exit) decision of shipowners. Finally, focusing on the LNG markets, Acciaro (2014) investigates the optimal time for investment in LNG retrofit and takes specific account of the value of an investment deferral strategy when compared to the advantages emanating from the immediate exploitation of fuel price differentials.…”

A Critical Review of the Literature on Firm-Level Theories on Ship Investment

“…The ROA is treated as an alternative method to manage capital budgeting process under uncertainty and irreversibility with additional options which can be exchanged with low-risk income streams associated with one strategy with that of another strategy (Bendall and Stent 2007). More recently, Balliauw (2017) applied ROA in container shipping to analyse the performance in the shipping markets of a theoretically developed model to market entry and exit decision of ship owners. The author found that the theoretical model, ROA, conforms to the real market values when the market is steady.…”