Fuel Hedging Outcomes and Ticket Pricing: An Empirical Look at the U.S. Airline Industry
27 Pages Posted: 5 Mar 2020 Last revised: 17 Oct 2020
Date Written: October 16, 2020
Major airlines rely on fuel hedging to manage risk of volatile fuel prices. We show that fuel hedging leads to lump sum gain or loss, which does not affect airlines' purchase cost of fuel (variable cost), but is incorporated into the reported airline fuel costs. Our estimation results suggest that differences in reported fuel costs across airlines (due to heterogeneous fuel hedging outcomes) lead to significant differences in ticket prices. In particular, a 10% reduction in the reported fuel cost (due to hedging gain) leads to a 2.2% reduction in ticket prices. We conduct several robustness checks, and rule out explanations such as intertemporal profit smoothing. Moving beyond pricing, we find that hedging outcomes have no impacts on the number of routes and flights which airlines operate. On the other hand, when enjoying hedging gain, airlines use larger aircrafts and reduce airtime of their flights. These impacts, while statistically significant, are fairly small in magnitude. Our results provide empirical evidence that fixed/sunk costs can affect firms' optimal price decisions and some non-price decisions, and establish a link between the financial market and the product market.
Keywords: Fuel hedging; Fuel cost; Full cost pricing; Airline pricing.
JEL Classification: D43, G32, L13, L93
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