Risk Management in Aviation Finance

This thesis provides an investigation into cross-hedging strategies for jet fuel risks concerning volatility and extreme tail risk, as well as the determining factors of default risk among tourism companies including airlines. There are three chapters, revolving around the central theme of risk management, particularly in the context of the aviation and tourism industries. Each of the three chapters attempts to understand and mitigate a different type of risk that these industries face. The first chapter addresses the volatility of jet fuel prices. This price volatility presents a significant financial risk to airlines, which can directly influence their profitability. Due to the limited direct hedging options, I propose a new composite cross-hedging approach to manage this risk, utilizing multiple oil commodity futures contracts and a recently introduced jet fuel swap contract via various hedging models and a mimicking portfolio approach. The proposed strategies are shown to provide substantial hedging performance benefits relative to a traditional single-instrument strategy and help to reduce the financial impact of jet fuel price fluctuations on airlines. This chapter has been published in the Journal of Commodity Markets. The second chapter focuses on the upside-tail risk of jet fuel from a long hedger's perspective. This type of risk refers to the potential large unexpected increases in jet fuel prices. It is a critically important concern for airlines, as they are sometimes willing to absorb small increases in fuel costs but large changes can have serious financial consequences. This chapter compares different hedging models, including parametric, non-parametric, and semi-parametric methods, as well as a Vine Copula approach, in order to identify the most effective way to minimize this risk. Interestingly, my results prove that the parametric OLS model has the best performance among the four, which is different from the findings of previous research. I also demonstrate that composite hedges perform best when the tail risk is at the most extreme, particularly when the oil markets have a high level of risk. Furthermore, all the hedging models that I examine perform much better during periods of low implied oil market volatility. The final chapter broadens the scope of default risk in the US tourism industry, which encompasses airlines as a subsector. This type of risk refers to the possibility that a company cannot meet its debt obligations, which may ultimately lead to bankruptcy. This chapter examines both firm-level and macroeconomic variables as the determinants of corporate default risk in the tourism industry, emphasizing that how a firm responds financially to the macroeconomic environment affects its default probability. The findings suggest that different factors become more important depending on whether the economy is in a good or bad economic condition. An upturn in the economy increases the impact of a firm's size, profitability, and capital expenditure, while a downturn increases the effects of market expectations, profitability, and liquidity. Besides, my results confirm that a company is less likely to default in favorable economic conditions and reveal that different patterns emerge among the five subsectors included. This chapter provides valuable insights for companies in managing their business to avoid default risk. While each chapter deals with a different kind of risk - jet fuel price volatility, jet fuel upside-tail risk, and corporate default risk -- they are fundamentally concerned with risk management for airlines as a special category of the tourism industry. The purpose of this research is to comprehend these risks and find an effective way to mitigate them. This study enriches the existing body of knowledge, by emphasizing the complexity of risk management in the airlines and tourism industry and highlighting the diverse strategies that can be applied to handle these risks.