Derivative hedging and value in the European airline industry

Timur Kovacevic & Håvard Olstad

Student thesis: Master thesis


The use of financial derivatives has steadily increased in the last decades, and today there are well-developed exchange trade markets for these financial instruments, as well as vast amounts being traded directly over-the-counter. Derivatives can be used for hedging purposes in risk management, or for speculative purposes. Many corporations and firms today engage in hedging activity, but it is not clear whether this has a positive effect on their market value of the firm. Both theory and evidence is inconclusive with regards to the possible impact derivative hedging has on non-financial companies’ firm value, which makes the observed high hedging activity interesting to study with regards to its impact on the firm value. The European airline industry is an interesting subject for studying the impact of derivatives hedging on firm value. This is because the industry displays relatively high levels of hedging activity, as well as many characteristics that makes it consistent with many theoretical assumptions of when derivatives hedging can be beneficial to firms’ values. In short, the industry is competitive, comprise many large firms, and all the firms share a similar and substantial exposure to a highly volatile commodity price risk, namely jet fuel. Jet fuel is a highly volatile commodity, and constitutes a significant fraction of airline firms’ operating expenses. Theory predicts, that under such circumstances, firms may choose to hedge in order to increase firm value, by reducing several problems and costs associated with their risk exposures. This thesis presents this relevant theory, as well as competing theories that oppositely argue that hedging generally does not increase firm value, and occurs due to other reasons, and relate the theories to the specific European airline industry. Consistent with this theory, it seems plausible that hedging in the European airline industry occurs due to firms’ attempts to increase firm value, and that hedging can in fact improve these firms’ values. To empirically examine these claims and theoretical predictions of hedging practices and impact on firm value in the airline industry, a quantitative analysis is conducted. The findings do not, however, uniformly support these expectations. Possible explanations are discussed, and overall the question of whether hedging can directly increase firm value, remains relatively open.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2011
Number of pages117