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Wednesday, March 23, 2005

Hedging Fuel Price Risk

Lynne Kiesling at Knowledge problem makes some interesting points about hedging. She references this prior post at Stumbling and Mumbling about truckers in the U.K. grumbling about higher fuel prices. First, she reiterates Stumbling and Mumbling's thoughts on the different ways economists and non-economists regard markets (non-economists view markets as place where risks are taken, while economists view them as a place where risks can be laid off).

She then talks about how fuel hedging is common in the airline industry, but that the hedgers may be the one with higher cash flows. Hedgers in the airline industry will benefit from their foresight in one of two ways:

  1. They will have lower factor costs, and would therefore be could conceivably cut fares.
  2. Although not mentioned, if they don't cut fares, they will have greater cash flows, which could enable greater expansion.
Click here for the entire article.

There's been limited research in this area. However, one recent paper was presented at the last American Finance Association meeting, by Amrita Nain, titled The Strategic Motives for Corporate Risk Management. In short, she finds support for the notion that hedging decisions are based at least in part by the hedging decisions of other firms in the same industry. Click here for the working paper.

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