Does Fuel Hedging Make Economic Sense? The Case of the Us Airline Industry
49 Pages Posted: 23 Nov 2003
Date Written: September 16, 2002
Abstract
This paper investigates the fuel hedging behavior of firms in the US airline industry during 1994-2000 to examine whether such hedging is a source of value for these companies. The investment climate in the airline industry conforms well to the theoretic framework of Froot, Scharfstein, and Stein (1993). Specifically, airline industry investment opportunities correlate positively with jet fuel costs, while higher fuel costs are consistent with lower cash flow. Given that jet fuel costs are hedgeable, airlines with a desire for expansion may find value in hedging future purchases of jet fuel. The results show that jet fuel hedging is positively related to airline firm value. The coefficients on hedging indicator variables in regression analysis suggest that the hedging premium constitutes approximately a 12-16% increase in firm value. We find that the positive relation between hedging and value increases in capital investment. This result is consistent with the assertion that the principal benefit of jet fuel hedging by airlines comes from reduction of underinvestment costs.
Keywords: Hedging, Risk Management, Airline industry
JEL Classification: G30, G31, G32, L93
Suggested Citation: Suggested Citation
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