Modelling the investment decision of the entrepreneur in the tanker sector: choosing between a second-hand vessel and a newly built one

Abstract

It is often the case that the investor in the shipping sector faces the dilemma of investing in a second-hand vessel or building a new one. This happens because an active second-hand market for almost all kinds of vessels exists. We argue that one of the prime considerations for the investment decision should not be the price of the vessel per se, second-hand (SH) or newly built (NP) but (a) the relative price ratio (SH/NP) second-hand price over the new building price and (b) the movement of this ratio. We investigate the determinants of this ratio across different vessel sizes in the tanker sector and show that it can be used as an effective tool in investment decision as well as in asset appraisal. We employ monthly data between 1995 and 2006 for four different ship sizes–VLCC, Suezmax, Aframax and Handysize–and implement an error correction model. The investment decision depends on a number of risk and return variables as well as the perceived speed of adjustment of the price ratio to its equilibrium level. Overall we claim that the cyclicality of the shipping sector together with expectations formed by the agents operating in it (the entrepreneur, the ship-owner and the broker), determine the movement of the ratio and hence the decision of the entrepreneur.