Hedging In The Airline Industry

Andreas Pilgaard & Daniel Skov Jensen

Student thesis: Master thesis


This thesis analyzes jet fuel hedging of airlines with the purpose of explaining differences in hedging strategies. Through the analysis of financial and operational hedging the thesis attempts to explain hedging behavior, and how hedging is related to firm value and exposure.
Financial hedging is analyzed using the financial distress theory of Smith and Stulz (1985), and the investment coordination rationale of Froot et al. (1993) and Froot et al. (1994). The idea of the financial distress framework is, that airlines can lower their cost of debt through the use of hedging, that works to lower the probability of bankruptcy. The investment coordination framework states, that airlines should match internally generated cash flows and investment opportunities. The empirical analysis of financial distress finds, that airlines with higher interest expenses use more hedging. When testing whether debt levels and credit ratings affect hedging behavior, the results are inconclusive.
The analysis of the investment coordination framework shows, that hedging increases more for airlines with high cost of external financing than for airlines with low cost of external financing, when investment opportunities increase. This is in line with the framework.
The theories of financial hedging are tested through other hypothesis as well, but the results are mixed and we are unable to clearly confirm or reject the theories.Operational hedging is analyzed through leasing and the fleet diversity theory of Treanor (2012). The concept of these frameworks is that they provide flexibility for airlines. This flexibility should increase the airlines’ ability to adjust operations during periods of high fuel prices. Leasing and fleet diversity should therefore increase firm value and decrease exposure.
In the empirical analysis of leasing, we find that smaller airlines increase firm performance, when increasing the amount of leasing, while larger airlines decrease exposure. For fleet diversity we find evidence that all airlines on average are able to decrease exposure by increasing the level of fleet diversity.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2017
Number of pages135