Tuesday, 20 April 2010

Planes go down; Cars go up?

Following up on the Enron post, the ash cloud currently over Europe reminds of a great moment in that play when they explain the financial concept of hedging.

The character explains that if you invest only in airlines, then you put yourself at serious risk that planes might start falling out of the sky. So you would ‘hedge’ your investment by buying shares in car hire firms. “Planes go down; car hire goes up.” At least so the theory goes.

The irony is quite acute. Of course no one expects planes to start falling out of the sky, but the nearest equivalent (that all planes are grounded) has taken place, for a completely unexpected reason. So does “The Enron Theory of Hedging” stand up to empirical testing? Here’s how the share prices look:

British Airways – down 4% Friday pm to Monday am
EasyJet – down 7% Friday pm to Monday am
Ryanair – down 4% Friday pm to Monday am

Avis Europe (car rental) – up 9% Friday pm to Monday pm
Hertz (car rental) – down 1% Friday pm to Monday pm
Go-Ahead (public transport and airport parking) – up 3% Friday pm to Monday pm

So the car rental hedge would have partly but not entirely worked. I should add that in calculating the airline percentages I have taken the Monday am price because they rallied later in the day, presumably on the back of expectations of either the flight ban lifting or even the possibility of a government bail-out.

In the longer term, the effect of a flight ban on Europe’s economies will be scrutinised in some detail. For now I would just like to congratulate the script writer of Enron (the play) for their prescience...

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