Riblet#11: Volatility’s a Business Killer

Question: How do you get a million dollars?

Answer: Start with a billion and go into the airline business.

Nineteen airlines went bust last year.  Poor risk management has been cited as the prime reason.

Hedging enables you to reduce uncertainty via financial instruments such as futures, swaps and options that can give you certainty over things that can be highly volatile, e.g. fuel costs (the biggest cost for an airline and often the most volatile).

Not all airlines hedge fuel costs and only a few hedge against currency swings or weather disruption.  A further volatility for airlines is passenger numbers: most airlines don’t get 90% of their ticket revenues until less than 90 days before departure, so forecasting revenues can be hard, especially as they can be subject to disruption owing to economic downturns in the market they are servicing, and security concerns in the destinations they are flying to. And on the other side, they have had to invest billions in planes, without an accurate picture of demand.

On any particular day, the price of a specific ticket for a specific flight can vary by an average of 16% in Europe (although somewhat less in Asia and North America), and this is an annoyance for customers, especially when it changes when you are about to book.

So Airbus, which has nine years’ worth of orders making their way through production right now, is setting up an exchange in London to help airlines hedge this uncertainty (and help make sure the airlines with those orders for Airbus planes remain in business). The only problem is that such hedging instruments need counterparties, and finding businesses (e.g. hotels or travel agents) to take the other side of the transaction may be tricky. Watch this space.  Is this the opportunity for an artificial intelligence-based business?

Data source:The Economist magazine

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