Charter market default risk: A conceptual approach

The aim of this paper is to investigate conceptually how charter market default risk will vary with freight market conditions, charter duration, and the financial situation of the charterer. The primary contribution is the development of a mathematical framework and numerical methodology to simulate the dynamic economic value of a period charter and the related risk of default, based on a fully functional stochastic spot freight rate model, which enables us to evaluate the sign and magnitude of the risk premium attributable to default risk. The results support the assertion that the risk premium attributable to charter default risk is positive and increasing in the spot freight rate level and period charter duration. The primary application is the evaluation of the economic value and financial risk inherent in period timecharters, for instance, by lending banks and credit rating agencies. (C) 2006 Elsevier Ltd. All rights reserved.