Derivatives on airline tickets September 3, 2007
Posted by James Webster in : finance , trackbackA couple of recent conversations I’ve had have been around airline tickets and what derivatives over airline tickets might look like. For any given airline, route, date, and class of travel, a ticket already has the property of fungibility. The other essential property to become a tradable commodity that airline tickets do not have at present is transferability. I imagine this is primarily due to security concerns but perhaps there are other reasons as well.
The presence of an active derivatives market over airline tickets would probably make it harder for airlines to segment their fare structures since so much of the segmentation revolves around the conditions under which a ticket can be changed for another date, route, etc. An options contract over a ticket could achieve the same thing with the premium for more flexible tickets (and risk) instead going to the option writer. However without the ability to hedge their exposures through purchasing a transferable pool of tickets for delivery to the option buyer the writers are unlikely to want to bear the risk.
What would an option over an airline ticket look like? In its most simplest form it would be a simple call/put as per standard vanilla equity options. The contract would probably specify certain parameters of the underlying ticket such as route and class, but other features such as airline and date of travel could be at the whim of the counterparty that delivers the ticket should the option be exercised. More complicated derivatives would be possible however, such as one tied to the on-time arrival of a flight.
How would you price such an option? The typical cost of existing tickets would certainly be one factor, sensitivity to swings in the price of jet fuel contributing to fuel surcharges could be another. Probably the popularity of the route at a given time of year might cause the option price to change significantly as it approaches expiry… options over routes that become heavily booked closer to the date of departure would probably increase in value. Are there any quants in the audience with other thoughts?
What would the overall consequences of such a derivatives market be? Would there be any negative consequences?
Given that some airlines frequently hedge their exposures to the price of jet fuel why cannot we hedge our exposure to the economic costs of our air travel? Of course there are also environmental costs of our air travel for which we should take more responsibility. However between airline ticket derivatives and weather derivatives (see also Investopedia and Weatherbill) you could synthesize a travel insurance policy covering your general satisfaction with your travel arrangements, providing a payout in the event of poor service or poor weather.
I have found one patent covering the concept of airline ticket derivatives but I am sure other work has been done in this area.
Comments»
I’ve done pretty extensive research on the topic and found one company in 2001 that tried do it. Fairair.com (cool name) http://findarticles.com/p/articles/mi_m0ZCK/is_20_11/ai_74799725
They ran across a number of obstacles. First, they had very limited inventory. They were only able to secure tickets from a couple of obscure airlines and unpopular routes. Second, they had difficulty getting around security issues regarding transferring names on the tickets. Most importantly, airlines believed this resell service was canabalizing their last minute ticket sales (the ticket’s with the highest premium) and their exorbitant change fees.
Here’s a recent article on the topic:
http://jetlagged.blogs.nytimes.com/tag/strange-economics/
A great case study none the less. I still believe it is possible. People still trade Southwest travel vouchers on eBay.
http://search.ebay.com/search/search.dll?from=R40&_trksid=m37&satitle=southwest+voucher&category0=