Hedging Price Volatility Using Fast Transport

39 Pages Posted: 21 Jul 2009  

David L. Hummels

Purdue University - Department of Economics; National Bureau of Economic Research (NBER)

Georg Schaur

University of Tennessee, Knoxville - College of Business Administration - Department of Economics

Date Written: July 2009

Abstract

Purchasing goods from distant locations introduces a significant lag between when a product is shipped and when it arrives. This is problematic for firms facing volatile demand, who must place orders before knowing the resolution of demand uncertainty. We provide a model in which airplanes bring producers and consumers together in time. Fast transport allows firms to respond quickly to favorable demand realizations and to limit the risk of unprofitably large quantities during low demand periods. Fast transport thus provides firms with a real option to smooth demand volatility. The model predicts that the likelihood and extent to which firms employ air shipments is increasing in the volatility of demand they face, decreasing in the air premium they must pay, and increasing in the contemporaneous realization of demand. We confirm all three conjectures using detailed US import data. We provide simple calculations of the option value associated with fast transport and relate it to variation in goods characteristics, technological change, and policies that liberalize trade in air services.

Suggested Citation

Hummels, David L. and Schaur, Georg, Hedging Price Volatility Using Fast Transport (July 2009). NBER Working Paper No. w15154. Available at SSRN: https://ssrn.com/abstract=1434670

David L. Hummels (Contact Author)

Purdue University - Department of Economics ( email )

West Lafayette, IN 47907-1310
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Georg Schaur

University of Tennessee, Knoxville - College of Business Administration - Department of Economics ( email )

508 Stokely Management Center
Knoxville, TN 37996-0550
United States

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