Fuel Hedging and Behavior Bias: An Empirical Look at the U.S. Airline Industry
23 Pages Posted:
Date Written: February 10, 2020
Major airlines rely on fuel hedging to manage risk of volatile fuel prices. They also include fuel hedging gain/loss in their reported fuel cost (accounting cost), even though hedging has no impact on their fuel purchase cost (economic cost). Our results show that airlines use the accounting cost, rather than the economic cost of fuel when making ticket pricing decisions. In particular, a 10% reduction in the reported fuel cost (due to hedging gain) leads to a 2.4% reduction in ticket prices. This finding can also be interpreted as sunk cost fallacy. That is, fuel hedging gain/loss, while sunk, affects airlines' ticket pricing decisions. This suggests that professionals are susceptible to behavior bias even in major business decisions. We conduct several robustness checks and also rule out alternative explanations such as intertemporal profit-smoothing.
Keywords: Fuel hedging; Fuel cost; Airline pricing; Sunk cost fallacy.
JEL Classification: D43, G32, L13, L93
Suggested Citation: Suggested Citation