Fine‐Tuning a Corporate Hedging Portfolio: The Case of an Airline

15 Pages Posted: 23 Dec 2013

See all articles by Mathias Gerner

Mathias Gerner

European Business School Oestrich-Winkel - Department of Finance

Ehud I. Ronn

University of Texas at Austin - Department of Finance

Date Written: Fall 2013

Abstract

Industrial companies typically face a multitude of risks that could cause significant fluctuations in their cash flow. This is a case study of the hedging strategy adopted by an international air carrier to manage its jet‐fuel price exposure. The airline's hedging approach uses “strips” of monthly collars constructed with Asian options whose payoffs are based on average of “within‐prompt‐month” oil prices. Using the carrier's own implicit objective function based on an annual granularity, the authors show how the air carrier could fine‐tune its current hedge portfolio by adding tailored exotic options. The article describes annual average‐price options, provides an explicit valuation of them, and considers how such instruments may affect corporate liquidity. Consistent with its annual objective function, the airline made this exotic derivative the central tool to hedge across all potential realized values of annual jet‐fuel spot prices. The authors believe this modified portfolio is better suited to address the firm's hedging cost and its overall exposure to jet‐fuel price fluctuations.

Suggested Citation

Gerner, Mathias and Ronn, Ehud I., Fine‐Tuning a Corporate Hedging Portfolio: The Case of an Airline (Fall 2013). Journal of Applied Corporate Finance, Vol. 25, Issue 4, pp. 74-86, 2013, Available at SSRN: https://ssrn.com/abstract=2371493 or http://dx.doi.org/10.1111/jacf.12044

Mathias Gerner (Contact Author)

European Business School Oestrich-Winkel - Department of Finance ( email )

Gustav-Stresemann-Ring 3
Wiesbaden, Hessen 65189
Germany

HOME PAGE: http://www.ebs.edu/

Ehud I. Ronn

University of Texas at Austin - Department of Finance ( email )

Graduate School of Business
Austin, TX 78712
United States
512-471-5853 (Phone)
512-471-5073 (Fax)

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