Hedging Price Volatility Using Fast Transport
David L. Hummels
Purdue University - Department of Economics; National Bureau of Economic Research (NBER)
University of Tennessee, Knoxville - College of Business Administration - Department of Economics
NBER Working Paper No. w15154
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.
Number of Pages in PDF File: 39
Date posted: July 21, 2009