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Designing optimal jet fuel hedging strategies for airlines – Why hedging will not always reduce risk exposure

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  • Swidan, Hassan
  • Merkert, Rico
  • Kwon, Oh Kang

Abstract

Using a historical simulation based Value at Risk (VaR) model, we provide the first empirical study quantifying the benefits and the costs associated with the fuel hedging activities of airlines. More specifically, we quantify the jet fuel risk exposure and estimate the cash collateral required to support jet fuel hedging using exchange traded futures. The results from our VaR model suggest that although hedging significantly reduces risk exposure, the associated collateral costs are large enough to offset, to a large extent, the potential financial benefits of the hedge to airlines. Increasing the hedging ratio beyond 60–70% results in a marginal reduction in the market risk exposure but significantly increases the cash collateral requirements. Our results demonstrate that the amount of cash collateral is a key factor in hedging decisions of airlines and, while this somewhat contradicts extant literature, is consistent with recent management practice.

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  • Swidan, Hassan & Merkert, Rico & Kwon, Oh Kang, 2019. "Designing optimal jet fuel hedging strategies for airlines – Why hedging will not always reduce risk exposure," Transportation Research Part A: Policy and Practice, Elsevier, vol. 130(C), pages 20-36.
    • Handle: RePEc:eee:transa:v:130:y:2019:i:c:p:20-36
    DOI: 10.1016/j.tra.2019.09.014
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