Liquidity effects and FFA returns in the international shipping derivatives market

•First study on the investigation of the impact of liquidity risk in freight derivatives excess returns.•A unique database obtained by a major shipbroker to examine bid-ask spreads of freight derivatives.•Liquidity factors and their magnitude are essential for pricing and forecasting freight derivatives.•Liquidity risk is priced in the market and both liquidity measures used have a positive and significant effect.•Results help participants in the maritime transportation industry in trading freight derivatives.

The study examines the impact of liquidity risk on freight derivatives returns. The Amihud liquidity ratio and bid–ask spreads are utilized to assess the existence of liquidity risk in the freight derivatives market. Other macroeconomic variables are used to control for market risk. Results indicate that liquidity risk is priced and both liquidity measures have a significant role in determining freight derivatives returns. Consistent with expectations, both liquidity measures are found to have positive and significant effects on the returns of freight derivatives. The results have important implications for modeling freight derivatives, and consequently, for trading and risk management purposes.