Hedging Price Volatility Using Fast Transport

Date Added: Feb 2010
Format: PDF

Purchasing goods from distant locations introduces a significant lag between when a product is shipped and when it arrives. These transit lags are trade barriers for firms facing volatile demand, who must place orders before knowing the resolution of demand uncertainty. This paper provides a model in which airplanes bring producers and consumers together in time. Fast transport allows firms to respond quickly to favorable demand realizations and to limit the risk of unprofitably large quantities during low demand periods. The model predicts that the likelihood and extent to which firms employ air shipments is increasing in the volatility of demand they face, decreasing in the air premium they must pay, and increasing in the contemporaneous realization of demand. This paper confirms all three conjectures using detailed US import data.