Explaining price differences between physical and derivative freight contracts

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.