Valuation of Lease Contracts with a Price Adjustment Option: An Application to the Maritime Transport Industry

Abstract

In volatile lease markets, a fixed rate contract may allow one contract party to gain excessive profits while letting the other party face substantial losses. The flexibility in adjusting the contract rate can help address this issue and maintain a fair long-term relationship. This article models and prices the flexibility using real options and derives the boundary of option exercise to facilitate the optimal decision on the rate adjustment. The proposed method is applied to time charter contracts in the maritime transport industry. Moreover, the level of flexibility can be tailored to meet different budgets for the flexibility.

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Notes on contributors

Ahmed A. A. al sharif

Ahmed A. A. Al sharif received his Ph.D. and M.S. in engineering management from Missouri University of Science and Technology. He received his bachelor’s degree in mechanical engineering from Tripoli University, Libya, and his MBA from the Higher Studies Academy, Libya. His research interests are in the areas of real options, project management, and operations research in manufacturing.

Ruwen Qin

Ruwen Qin is an assistant professor of engineering management and systems engineering at Missouri University of Science and Technology (formerly University of Missouri–Rolla). She received her Ph.D. in industrial engineering and operations research from Pennsylvania State University and her M.E. and B.E. degrees in aerospace engineering from Beijing University of Aeronautics and Astronautics, China. Her research interests are in the fields of real options, financial engineering, operations research, and their applications to manufacturing and service operations, energy systems, transportation, and workforce management. She has been a member of the Institute for Operations Research and Management Sciences (INFORMS) since 2005.