An analysis on the causal relationship between freight rate and newbuilding orders: Implications for Korean trade and shipbuilding companies

Abstract

Purpose

The purpose of this paper is to provide implications for forecasting export of Korean shipbuilding industry that is suffering from deadlock in newbuilding orders, by investigating the causal relationship between freight rate earnings and newbuilding orders in the shipbuilding market.

Design/methodology/approach

Using a sample of freight rate earnings and newbuilding orders (in various terms) over the period 1996-2016, Granger causality between the two variables are examined in a vector autoregressive (VAR) model. In addition, the potential asymmetry of the causal relationship according to bullish and bearish market conditions is also investigated using a combination of moving averages of different time spans.

Findings

The results indicate a uni-directional causality running from freight rate earnings to newbuilding orders. This finding implies that shipowners’ confidence in the shipping freight market is particularly important determinants in their newbuilding investment, which is consistent with the overconfidence hypothesis. However, the causality does not vary according to different market conditions.

Research limitations/implications

This study offers several importation contributions. First, the authors provide evidence that newbuilding orders are positively associated with increase in freight rate earnings. Second, the authors document a causality running from changes in freight rate earnings to the volume of newbuilding orders. These findings support the theoretical expectation of the overconfidence hypothesis. Third, contrary to the findings in the financial market, there is no asymmetric response of the volume of newbuilding orders in bullish and bearish markets. Fourth, this study provide implications for management of Korean shipyards by providing evidence on driving force of newbuilding investment decisions of their customers (shipowners).

Practical implications

The findings in this study suggest implications for management of Korean shipyards by providing evidence on driving force of newbuilding investment decisions of their customers, as well as determinants of shipbuilding export, an important source of Korea’ national income.

Social implications

The analysing the major determinants of shipbuilding exports, the findings in this study presents understanding of market cycles in shipbuilding, an important source of Korea’s national income and balance of payment.

Originality/value

This study is the first attempt to analyse the relationship between freight rate earnings and newbuilding investment in the context of the behavioural theory in economics.

Citation

Kim, C.Y. and Park, K. (2017), "An analysis on the causal relationship between freight rate and newbuilding orders: Implications for Korean trade and shipbuilding companies", Journal of Korea Trade, Vol. 21 No. 1, pp. 22-37. https://doi.org/10.1108/JKT-11-2016-0039