Dynamic Optimality of Airline Fuel Cost Hedging

Corporate hedging creates value only when the hedging is optimal, but maintaining a dynamically optimal hedging practice is a non-trivial task. This article takes the US airline as an example and examines the dynamic optimality of airline fuel cost hedging. We derive an airline’s optimal fuel cost hedging ratio as a function of the airline’s revenue and cost sensitivities and the time-varying demand shock contribution in the oil price movement. We construct a fuel cost hedging demand index based on the estimated oil price dynamics and use its correlation with an airline’s hedging ratio as a dynamic optimality measure of the airline’s hedging practice. The optimality measure strongly predicts the airline’s firm value, but less than a third of US airlines show positive dynamic optimality.