Fuel Hedging and Behavior Bias: An Empirical Look at the U.S. Airline Industry

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Long Shi

University of Oklahoma - Department of Economics

Qihong Liu

University of Oklahoma - Department of Economics

Myongjin Kim

University of Oklahoma

Date Written: February 10, 2020

Abstract

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

Shi, Long and Liu, Qihong and Kim, Myongjin, Fuel Hedging and Behavior Bias: An Empirical Look at the U.S. Airline Industry (February 10, 2020). Available at SSRN: https://ssrn.com/abstract=

Long Shi

University of Oklahoma - Department of Economics ( email )

729 Elm Avenue
Norman, OK 73019-2103
United States

Qihong Liu (Contact Author)

University of Oklahoma - Department of Economics ( email )

Norman, OK 73019-2103
United States
405-325-5846 (Phone)

HOME PAGE: http://qliu.oucreate.com

Myongjin Kim

University of Oklahoma ( email )

307 W Brooks
Norman, OK 73019
United States

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