Hedging and Value in the U.S. Airline Industry

This article discusses the findings and practical import of the authors' study of the fuel hedging activity of 28 U.S. airlines during the period 1992‐2003. The aim of the study was to answer the following question: Does fuel hedging add value to the airlines and, if so, how? The airline industry provides a natural experiment for investigating the relation between hedging and value for a number of reasons: (1) the industry is by and large competitive and remarkably homogeneous; (2) airlines are exposed to a single, volatile input commodity—jet fuel—that represents a major economic expense for all competitors; and (3) fuel price increases cannot be easily passed through to customers because of competitive pressures in the industry. The results of the study show that jet fuel hedging is positively related to airline firm value. Those airlines that hedged their fuel costs had Tobin's Q ratios that were 5‐10% higher, on average, than those of airlines that did not hedge. What's more, the higher the proportion of future fuel requirements hedged, the larger the valuation premium. The authors' results also suggest that the main source of value added by hedging in the airline industry is its role in preserving the firm's ability to take advantage of investment opportunities that arise when fuel prices are high and airline operating cash fl ows and values are down. Consistent with this argument, the study finds that the value premium associated with hedging increases with the level of the firm's capital spending. The authors also report that the most active hedgers of fuel costs among the airlines are the larger firms with the least debt and highest credit ratings. This result is somewhat surprising, at least to the extent that smaller airlines are expected to have larger financial distress costs (as a percentage of firm value) and hence greater motive to hedge. One explanation is that the smaller airlines have lacked either sufficient resources or the strategic foresight to acquire a derivatives hedging capability. A second possibility—one that is consistent with the study's main findings—is that the largest airlines also have the highest costs of financial distress (even as a percentage of firm value) in the form of larger growth opportunities that could be lost as a result of high leverage and financial risk. In other words, only the largest airlines are typically able to buy distressed assets during periods of industry weakness; to the extent this is so, such firms may also have the most to gain from hedging.     

Managerial Risk-Taking Incentives and Executive Stock Option Repricing: A Study of US Casino Executives

I examine the relation between managerial incentives from holdings of company stock and options and stock option repricing. Because options provide incentives to increase both risk and stock price, firms must realize that as options go underwater, executives might face incentives to invest in risky, negative NPV projects. Repricing may alleviate such incentives. I examine repricing activity by firms in the US gaming industry and find that risk-taking incentives from options are positively related to the incidence of executive option repricing. The results support the hypothesis that repricing assists firms in alleviating excessive risk-taking incentives of senior management.     

The effect of prime age adult mortality on household composition and consumption in rural Ethiopia

Using panel data from Ethiopia covering 1994–1997, we estimate the impact of prime age adult mortality on household composition, household expenditures and dietary diversity. We employed propensity score matching with a difference-in-difference estimator to control for endogeneity of mortality to the outcomes of interest. Households losing a productive adult did not replenish the lost labor, regardless of economic status, sex or status of the deceased adult. With the exception of non-poor households, adult mortality resulted in increased dependency ratios, but did not adversely affect households’ expenditure patterns (total, food and non-food expenditures) regardless of the sex and position of the deceased and the economic status of the households. Although food expenditures were protected, a decline in dietary diversity, especially among the poorest households, reflected increased nutrition insecurity associated with adult mortality.     

ESTIMATING DIRECTIONAL MIGRATION FLOWS FROM AGE-SPECIFIC NET MIGRATION DATA

This paper focuses on a method for indirectly inferring migration flows in the absence of migration data, using two successive counts of birthplace-specific population stocks . Such stocks have been used in the past to infer patterns of mortality and indeed of net migration. But a workable method for using such population stocks to indirectly estimate directional migration flows still eludes us. Widely observed regularities in the age patterns of outmigration indicate that age-specific propensities of migration are correlated, and this characteristic suggests an estimation method that directs attention to the age-specific relative propensities of two or more flows exhibited in the historically preceding time intervals, and then uses those past measures of relative propensities to disaggregate residually estimated net migration flows into the underlying contributions of inmigration and outmigration. A detailed demonstration of the method, applied to US data, is set out in this paper.     

Fast accurate binomial pricing

We discuss here an alternative interpretation of the familiar binomial lattice approach to option pricing, illustrating it with reference to pricing of barrier options, one- and two-sided, with fixed, moving or partial barriers, and also the pricing of American put options. It has often been observed that if one tries to price a barrier option using a binomial lattice, then one can find slow convergence to the true price unless care is taken over the placing of the grid points in the lattice; see, for example, the work of Boyle & Lau [2]. The placing of grid points is critical whether one uses a dynamic programming approach, or a Monte Carlo approach, and this can make it difficult to compute hedge ratios, for example. The problems arise from translating a crossing of the barrier for the continuous diffusion process into an event for the binomial approximation. In this article, we show that it is not necessary to make clever choices of the grid positioning, and by interpreting the nature of the binomial approximation appropriately, we are able to derive very quick and accurate pricings of barrier options. The interpretation we give here is applicable much more widely, and helps to smooth out the ‘odd-even’ ripples in the option price as a function of time-to-go which are a common feature of binomial lattice pricing.     

Homophily and long-run integration in social networks

We model network formation when heterogeneous nodes enter sequentially and form connections through both random meetings and network-based search, but with type-dependent biases. We show that there is “long-run integration”, whereby the composition of types in sufficiently old nodes? neighborhoods approaches the global type-distribution, provided that the network-based search is unbiased. However, younger nodes? connections still reflect the biased meetings process. We derive the type-based degree distributions and group-level homophily patterns when there are two types and location-based biases. Finally, we illustrate aspects of the model with an empirical application to data on citations in physics journals.     

Collaborating Smartly: The Role of Open Strategy in Absorptive Capacity

Research on open strategy suggests that shared knowledge through collaboration can generate co‐created value. We explore this idea by assessing it as a predictor of absorptive capacity (ACAP) in cross‐sector partnerships in pursuit of social innovation. The findings of our study indicate that aspects of strategic openness, including a shared sense of interdependence toward a mutual goal, are the primary mechanisms that enhance knowledge accretion in cross‐sector partnerships. The data also suggest that formalized organizational mechanisms are more influential for producing ACAP than informal mechanisms.