Effectiveness of the operational and financial hedge: Evidence from the airline industry

Abstract

Scope and Method of Study: The purpose of this study is to examine the airline industry's exposure to jet fuel prices. Furthermore, this study tests whether operational and financial hedges are: effective at reducing an airline's exposure to the price of jet fuel, substitutes or complements, or value enhancing to an airline.

Findings and Conclusions: This research shows that both operational and financial hedges are effective at reducing an airline's risk exposure to the price of jet fuel. Furthermore, there is evidence that airlines use operational and financial hedges as complements. Lastly, and most surprisingly, the use of operational hedges destroys the airline's value. However, the evidence that financial hedges increase a firm's value is inconclusive. The findings of this research also show that an airline's exposure to the price of jet fuel is higher when the price of jet fuel is above historical norms. In additional, an airline's exposure to fuel prices increases as fuel prices rise. Lastly, the findings do not show that the airline industry experiences a greater level of exposure to the price of fuel when the volatility of the price of fuel is above or below its historical norm.