Does Fuel Hedging Make Economic Sense? The Case of the Us Airline Industry

49 Pages Posted: 23 Nov 2003

See all articles by David Carter

David Carter

Oklahoma State University - Stillwater - Department of Finance

Daniel A. Rogers

Portland State University - School of Business Administration

Betty J. Simkins

Oklahoma State University - Stillwater - Department of Finance

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

Carter, David A. and Rogers, Daniel A. and Simkins, Betty J., Does Fuel Hedging Make Economic Sense? The Case of the Us Airline Industry (September 16, 2002). AFA 2004 San Diego Meetings. Available at SSRN: https://ssrn.com/abstract=325402 or http://dx.doi.org/10.2139/ssrn.325402

David A. Carter

Oklahoma State University - Stillwater - Department of Finance ( email )

Spears School of Business
Stillwater, OK 74078-4011
United States
405-744-5104 (Phone)
405-744-5180 (Fax)

Daniel A. Rogers

Portland State University - School of Business Administration ( email )

P.O. Box 751
Portland, OR 97207-0751
United States
503-725-3790 (Phone)
503-725-5850 (Fax)

Betty J. Simkins (Contact Author)

Oklahoma State University - Stillwater - Department of Finance ( email )

336 Business Building
Stillwater, OK 74078-4011
United States
405-744-8625 (Phone)
405-744-5180 (Fax)

HOME PAGE: http://spears.okstate.edu/~simkins

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