Airline Fuel Hedging and Ticket Prices

Associate Professor, University of Oklahoma.

Upload/File/2019/5/20190523024935587.pdf

Major U.S. airlines rely on hedging to reduce the volatility of jet fuel costs across time. Depending on the hedging outcomes, fuel costs can vary (sometimes significantly) across airlines at a given time. Hedging gain/loss comes in the form a lump sum amount, and does not affect airlines’ marginal cost. Consequently hedging gain/loss should not affect airlines’ ticket pricing decisions. Yet we find that hedging gain/loss, which affects the accounting cost but not true economic cost of fuel, impacts ticket prices significantly (both statistically and economically). Our results suggest that airlines, when making ticket pricing decision , use accounting cost instead of economic cost (the true opportunity cost) of fuel. This can also be interpreted as sunk cost fallacy since the hedging gain/loss is sunk at the time of ticket pricing decisions. We then look for and test alternative explanations.