Spring 2016 (vol. 55, 1)

Airline Fuel Hedging: Do Hedge Horizon and Contract Maturity Matter?

Abstract

Large and unpredictable swings in fuel prices create financial uncertainty to airlines. While there are the risks for going unhedged, airlines that hedge to mitigate fuel price risk face the basis risk. This paper examines whether the length of hedge horizon and distance to contract maturity affect the effectiveness of jet fuel cross hedging. Understanding the effects of hedge duration and futures contract maturity helps improve airline?s fuel hedging strategies. We find that (1) regardless of the distance to contract maturity, weekly hedge horizon has the highest effectiveness for jet fuel proxies like heating oil, Brent, WTI, and gasoil; (2) heating oil is the best jet fuel proxy for all hedge horizons and contract maturities; and (3) the hedge effectiveness of heating oil is higher for one-month and three-month contracts.

by Siew Hoon Lim and Peter a. Turner