Fuel Hedging in the Airline Industry: Relations between Risk Exposure Firm Characteristics and Hedging Practices

Frederik Kobbernagel & Stefan Ruud Tangsgaard

Student thesis: Master thesis


The importance of risk management can no longer be questioned, and even though it has a long history, it is increasing in magnitude each and every day. Whether in organizations or business entities make no difference regarding the beneficial effects of risk management. The airline industry has proven to be a brilliant choice to examine risk management. More specifically, hedging is in the center. Hedging, in our dissertation, is performed by using different derivatives on different fuel types to lower volatilities of cash flows. Furthermore, there is no evidence of airlines using derivatives for speculative purposes. Specifically, we do not find any industry-wide standard that connects the type of airline and its respective use of derivatives and/or jet fuels, but combinations of (call) options on crude oil as well as collars and swaps on jet fuel are preferable by the airlines in our sample. The former, options on crude oil, is an example of cross-commodity hedging and though crude oil is commonly used, we find heating oil to be a better cross-commodity compared to jet fuel. Throughout the dissertation, two opposing theories help shape the direction and pose an incessantly, critical approach to the preparation. To put it unjustly simple, whether more constrained firms hedge more or less is the essence. The first theory states, if external financing, which is more common for more constrained firms, is costlier than internally generated funds, there is an incentive to hedge. The second theory states, financially constrained firms do not hedge because the return of investing is higher than that of hedging. Their contradictory conclusions originate from whether the cost of external financing and collateral constraints are included. By using fixed entity effects as our primary model, we find a negative relationship between net worth and hedge ratios as well as a positive relationship between net financing cost of debt and hedge ratios. Both supports the first of our theories. By using our results, a more detailed discussion of the two opposing theories’ practical application can be executed, especially when the second theory already has been tested empirically previously. The above constitutes our thesis, and had it not been for space limitations, we would also have looked into credit ratings and currencies. Furthermore, since earlier, empirical findings have found an opposite result than that of ours, it would be of great interest to have more overlapping years; to more critically assess the potential differences.

EducationsMSc in Finance and Investments, (Graduate Programme) Final ThesisMSc in Advanced Economics and Finance, (Graduate Programme) Final Thesis
Publication date2018
Number of pages145
SupervisorsCarsten Sørensen