Pierre Aury’s guide to volatility and shipping

The dry bulk shipping market is known for its volatility. Recently, we explored this topic, highlighting the high levels of fluctuation in the dry bulk spot market. However, many people focus solely on this volatility without realizing that it does not directly affect all players in the shipping industry. Unlike the electricity market, where volatility can have immediate consequences, shipping operates differently. In this article, we will delve deeper into the concept of volatility in shipping, particularly focusing on the use of standard deviation as a measure of market risk.

The Nature of Volatility in Shipping

Volatility in the shipping market is a complex issue. Many people fixate on the fluctuations of the spot market, but it is essential to understand that not everyone in shipping is exposed to these changes. Freight Forward Agreement (FFA) traders often engage in trading contracts for various time frames, such as the front month or front quarter. They do not trade the spot market directly. Instead, shipowners typically fix their vessels every 30 to 60 days, which provides a buffer against immediate market volatility.

The dry bulk market’s volatility is often measured using standard deviation, a statistical tool that gauges the dispersion of returns. However, this method has its limitations. For standard deviation to be a reliable measure, certain assumptions must be met. One key assumption is that returns are normally distributed, forming a bell curve. In reality, this is rarely the case, especially in shipping. Returns are often skewed, meaning that extreme values can significantly impact the average. For instance, in 2023, the average return of the capesize TC basket was only +0.5%, indicating a lack of stability.

NYK Makes Nature Positive Declaration and Joins 30by30 Alliance

Furthermore, the concept of tail risk complicates matters. Tail risk refers to the potential for extreme outcomes that lie outside the expected range. In shipping, this risk is often more pronounced than what standard deviation suggests. The volatility of the capesize TC basket can vary significantly depending on the time period used for analysis. This variability raises questions about which trailing period to choose for assessing risk. Different stakeholders, such as chief revenue officers and portfolio managers, may advocate for different time frames, leading to conflicting assessments of risk.

Challenges of Measuring Volatility

Measuring volatility in the shipping market presents several challenges. One major issue is the fluctuation of standard deviation based on the trailing time period selected for analysis. The volatility of the capesize TC basket can change dramatically depending on the observation period. This inconsistency can lead to confusion and misinterpretation of market conditions.

Moreover, the dynamic nature of the market means that conditions can shift rapidly. A period of relative stability can be followed by sudden spikes in volatility. This unpredictability makes it difficult for stakeholders to make informed decisions based on standard deviation alone. As a result, some experts suggest using alternative methods, such as Monte Carlo simulations, which utilize long-term historical data to provide a more comprehensive view of risk.