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The relation between bid–ask spreads and price volatility in forward markets

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The forward freight agreement (FFA) market developed in the 1990s and is growing very fast as the main derivatives market offering agents in the shipping and transportation industry a risk management instrument. This paper examines the relationship between expected volatility and bid–ask spreads (BASs) in this derivatives market where the underlying asset is a service rather than physical or financial assets. The study employs a two-step modelling specification. In the first step, the GARCH specification is used to model the volatility of the FFA prices; in the second step, the relationship between expected conditional volatility (led by one day) and the current BAS using the generalised method of moments (GMM) approach is investigated. The results indicate that there is a positive relationship between BASs, and expected price volatility in three out of four FFA contracts, after other factors are controlled.Derivatives Use, Trading & Regulation (2005) 11, 105–125; doi:10.1057/palgrave.dutr.1840012
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Document Type: Research Article

Affiliations: 1: 1HSBC Professor of Banking and Finance at City University Cass Business School in London, and Visiting Professor of Finance at ESCP-EAP, Paris 2: 2Faculty of Finance, City University Cass Business School, 106 Bunhill Row, London, EC1Y 8TZ, UK., Tel: +44 207 0400 199, Email: [email protected] 3: 3Assistant professor of finance and Academic Director of the MBA in Shipping Program at ALBA Graduate Business School, Athens, Greece

Publication date: 01 September 2005

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