Airfare price insurance: a real option model

Abstract

Purpose

The purpose of this paper is to examine the uncertainty of acquiring the lowest possible airfare when contemplating the purchase of a ticket. A real option model is applied to value insurance contracts that could be offered to passengers to cope with price risk. Furthermore, the premiums charged for such airfare price insurance contracts can augment airline carrier revenues.

Design/methodology/approach

Prices on 14 airfares were collected for 79 consecutive days on an assortment of US domestic and international flights from four airline carriers. Volatility in airfares was shown using the price range and SD. The Black‐Scholes‐Merton model was employed to value the call and put options representing different airfare price insurance contracts.

Findings

Airfare price insurance contracts affordability was demonstrated ranging from 1.55 to 11.28 percent of the average dollar ticket price.

Research limitations/implications

The valuations in the paper were based on ex post data that would not be available to the customer purchaser. Nonetheless, the airline carriers that sell the insurance would have better estimates of the price volatility and therefore could price the contracts to make a profit.

Practical implications

Airline passengers would have an opportunity to reduce the ticket price risk they face when buying their tickets. Airline carrier could increase revenues by offering such products.

Social implications

The opportunity to manage price risk contributes to the completeness of markets.

Originality/value

The paper shows that airfare price insurance contracts are a viable tool in the management of price risk.

Citation

Jain, A.K. and Cox, R.A.K. (2011), "Airfare price insurance: a real option model", Journal of Risk Finance, Vol. 12 No. 1, pp. 5-14. https://doi.org/10.1108/15265941111100030