A cointegrating stock trading strategy: application to listed tanker shipping companies

Abstract

In the current paper, we propose a strategy to trade a portfolio of listed shipping companies in the US market. In particular, we estimate a co-integrating relationship between the weekly stock market returns of a portfolio of tanker shipping companies and the Baltic Tanker Index, exploiting the close relationship between freight rates and the stock market performance of shipping companies. Our results suggest that a trading strategy on the basis of a co-integrating relationship and a simple moving average rule outperforms, by approximately 50%, a standard buy-and-hold strategy in various investment horizons, often by a very wide margin. Given the latter, the results allow us to enhance the current literature on shipping finance by providing evidence of how simple investment strategies can benefit both retail and institutional investors who do not have direct exposure or experience in the shipping industry by allowing them to include shipping stocks in their portfolios.

The shipping industry has not been open for a wider circle of investors since its inception (Harlafti and Papakonstantinou 2013). Ties within the industry have been close and family relationships have been, most often than not, predominant (Harlaftis and Theotokas 2007). Nevertheless, the increase in vessel prices since the 1970s has brought up the question of whether shipping companies should use external lending financing or float in the markets. Nonetheless, it was not until the mid-2000s that an increasing number of shipping enterprises decided to relinquish information of their modus operandi and enlist in the world stock markets (Merikas et al. 2009).

The increased number of companies in the market provided investors with an alternative way to invest in the shipping industry. Interested parties no longer need to acquire actual assets (vessels) but only hold stocks of shipping companies. Even in this case, however, little is currently known regarding the performance of the shipping companies in the stock market. The existing literature just provides information regarding IPOs (Merikas et al. 2009) and M&As (Alexandrou et al. 2014) in the industry. Nonetheless, there exists no study, at least to our knowledge, which employs a trading strategy based solely on shipping stock companies.

In the current paper, we build on the literature’s premise that freight rates are the predominant factor which affects the companies’ performance (see also next Section) and propose a trading strategy for a portfolio of tanker shipping companies that are listed in the US stock markets. As expected, we find that these companies exhibit a long-run common path with the Baltic Tanker Index. Given this relationship, we propose a long-short trading strategy on the basis of a cointegration model and a simple moving average rule, which appears to outperform the classic buy-and-hold approach across various investment horizons, often by a wide margin. We have employed the buy-and-hold approach as a benchmark of our strategy, since it tends to be denoted to investors that are not actively trading in the stock markets (Shilling 1992). Thus, we propose that the specific active trading technique, that we propose, can give higher returns when compared to a passive investment strategy.

The remainder of the paper is organized as follows: the next section provides a review of the existing literature on the shipping companies’ stock prices, their unique characteristics and the (non-stock market) trading strategies that have been introduced by other researchers. Section 3 presents the methodology and the data we have used, Section 4 offers the results and the last Section provides a general overview along with the conclusions reached by this paper.