Imperfect reversibility of air transport demand - effects of air fare fuel price and price transmission

Imperfect Reversibility of
Air Transport Demand:
Effects of Air Fare, Fuel Price & Price Transmission
Zia Wadud
Centre for Integrated Energy Research
Institute for Transport Studies
TRB Annual Meeting, January 2015

Background Conclusions
Results
Methodology
Objectives
Structure

Background Conclusions
Results
Methodology
Objectives

Background
• Air transport demand: an important planning parameter
• Traditional demand models perfectly reversible
• In practice demand could be ‘imperfectly’ reversible:
• Asymmetry and/or
• hysteresis

Background
• Asymmetry: magnitude of response during a rise of the
factor is different from that during a similar fall
P
Q Q
P
Y
Q Q

Background
• Hysteresis: response depends on previous history
P
Q
P
Y
Q Q
Y

Background
• Why ‘imperfectly’ reversible:
- Prospect theory
- Habits and practices
- Asset fixation
• Is air transport demand perfectly reversible
w.r.t. income and jet fuel prices?

Background
• Air transport demand imperfectly
reversible w.r.t –
Income &
Jet fuel price
• Both asymmetry & hysteresis effect –
for both variables
• Fuel price to ticket price/air fare?
Wadud (2014) the asymmetric effect of income
and fuel price on air transport demand

Role of price transmission?
Fuel price Ticket price
Passenger
demand
Imperfectly
reversible reversible
Imperfectly
Imperfectly reversible

Passenger
demandReversible reversible
Imperfectly

Passenger
demand
Imperfectly
reversible Reversible
Reversibility in
price transmission
Reversibility in
Behavioural response
Objective
• Is air transport demand imperfectly reversible wrt air fare?
• Is air fare imperfectly reversible wrt jet fuel prices?

Methodology
Passenger
demand
Imperfectly
reversible Reversible
Demand Elasticityfuel price = Fare elasticityfuel price × Demand Elasticityair fare
𝑙𝑛𝐷 = 𝛼′
𝑙𝑛𝑌 + 𝛾𝑙𝑛𝑃 + 𝜽′
𝑿′ 𝑙𝑛𝐷 = 𝛼𝑙𝑛𝑌 + 𝛽𝑙𝑛𝐹𝐴𝑅𝐸 + 𝜽𝑿

Methodology
• Time series econometric modelling
• 1979-2012 monthly data for US: RPEN/capita/day
• Decompose the explanatory factors into three series:
• All variables in logarithms- Cobb-Douglas
• Two demand equations: jet fuel price & air fare
𝑉𝑡
𝑚𝑎𝑥
= 𝑚𝑎𝑥(𝑉0, … . , 𝑉𝑡)
𝑉𝑡
𝑟𝑒𝑐
= 𝑚𝑎𝑥 0, (𝑉𝑖−1
𝑚𝑎𝑥
− 𝑉𝑖−1) − (𝑉𝑖
𝑚𝑎𝑥
− 𝑉𝑖)
𝑡
𝑖=0
𝑉𝑡
𝑐𝑢𝑡
= 𝑚𝑖𝑛 0, (𝑉𝑖−1
𝑚𝑎𝑥
− 𝑉𝑖−1) − (𝑉𝑖
𝑚𝑎𝑥
− 𝑉𝑖)
𝑡
𝑖=0
Historical maximum
Recovery/rise,
below maximum
Fall/cut

Methodology: Decomposition
Air fare decomposition
Income decompositionFuel price decomposition
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
-12
-10
-8
-6
-4
-2
0
2
4
6
8
10
Jan-79 Jan-82 Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09 Jan-12
Fuelpriceanditsdecomposition(inlog)
Time
fuel price - recovery series
fuel price - cut series
fuel price (right axis)
fuel price - maximum series (right axis)
5.3
5.4
5.5
5.6
5.7
5.8
5.9
6.0
6.1
6.2
6.3
-5
-4
-3
-2
-1
0
1
2
3
4
Airfareanditsdecomposition(inlog)
Time
airfare - recovery series
airfare - cut series
airfare (right axis)
airfare-maximum series (right axis)
10.0
10.1
10.2
10.3
10.4
10.5
10.6
10.7
-1.0
-0.5
0.0
0.5
1.0
Incomeanditsdecomposition(inlog)
Time
per capita income - recovery series
per capita income - cut seires
per capita income (right axis)
per capita income-maximumseries (right axis)

Methodology: Model Specification
𝑅𝑃𝐸𝑁𝑡
𝑐𝑑
= 𝜇 + 𝛼 𝑚𝑎𝑥 𝑌𝑡
𝑚𝑎𝑥
+ 𝛼 𝑟𝑒𝑐 𝑌𝑡
𝑟𝑒𝑐
+ 𝛼 𝑐𝑢𝑡 𝑌𝑡
𝑐𝑢𝑡
+ 𝛾 𝑚𝑎𝑥 𝑃𝑡
𝑚𝑎𝑥
+ 𝛾𝑟𝑒𝑐 𝑃𝑡
𝑟𝑒𝑐
+ 𝛾𝑐𝑢𝑡 𝑃𝑡
𝑐𝑢𝑡
+ 𝜅𝑈𝑡 + 𝜆𝑗 𝐷𝑗𝑡
4
𝑗=1
+ 𝜑 𝑘 𝑀𝐷𝑘𝑡
12
𝑘=2
+ 𝛾𝑖 𝑅𝑃𝑀𝑡−𝑖
𝑐𝑑
𝑙
𝑖=1
+ 𝜀𝑡
Income decomposition Price/Fare decomposition
Unemployment
Event dummies
9-11 attack etc.
Monthly dummies
Lagged dependent
• Dynamic model
• Cointegration tests
αmax = αrec = αcut; γmax = γrec = γcut

Results: Parameter Estimates
Air fare model Fuel price model
RPEN lag 1 0.596*** 0.607***
RPEN lag 12 0.132*** 0.112***
Ymax (income, max series) 0.156*** 0.370***
Yrec (income, cum. recovery series) 0.826*** 0.716***
Yfall (income, cum. fall series) 0.635*** 0.436***
FAREmax/Pmax (fare or price, max series) -0.229*** -0.097***
FARErec/Prec (fare or price, cum. recovery
series) -0.143*** -0.014***
FAREcut/Pcut (fare or price, cum. fall series) -0.113*** -0.001
Full estimation results suppressed

Results: Tests for Reversibility
Hypothesis Test restrictions F-stat
Fare model
F-stat
Price model
Imp. rev.: Income αmax = αrec = αcut
18.63*** 9.78***
Asymmetry: Income αrec = αcut
8.03*** 11.67***
Asymmetry: Income αmax = αcut
14.53*** 0.18
Hysteresis: Income αmax = αrec
33.17*** 7.20***
Imp. Rev.: Fare/Price βmax = βrec = βcut or γ’s 5.37*** 8.91***
Asymmetry: Fare/Price βmax = βcut or γ’s 7.54*** 7.52***
Asymmetry: Fare/Price βrec = βcut or γ’s 3.94** 17.80***
Hysteresis: Fare/Price βmax = βrec or γ’s 2.17 17.38***

Results: The Elasticities
Demand elasticity
wrt fuel price (γ)
Demand elasticity
wrt air fare (β)
Air fare elasticity
wrt fuel price
Maximum series -0.097*** -0.229*** 0.423***
Sub-maximum
recovery series
-0.014*** -0.143*** 0.100***
Fall series Insig. -0.113*** Insig.
= ×
Demand elasticityair fare > Demand Elasticityfuel price

Summary
With respect
to ..
Air transport demand Air fare (price transmission)
Asymmetry Hysteresis Overall Asymmetry Hysteresis Overall
Income Yes Yes Yes
Fuel price Yes Yes Yes Yes Yes Yes
Air fare Yes No? Yes
• Evidence of imperfect reversibility in air travel demand
- With respect to income, fuel price, air fare
• Evidence of imperfect reversibility in price transmission

Implications
• Reversible elasticity estimates can be biased
- yet long run demand forecast okay-ish
• Larger income elasticity during post-recession recovery
- short-term forecasting, planning, revenue management?
• Larger price/fare elasticity for increases above maximum
- fuel tax/carbon pricing policies
• Falling fuel price benefits not passed on to consumers
- regulatory oversight?

Future Work
• Heterogeneity in market types lost in aggregation:
- travel purpose, travel class, travel distance, presence &
type of competition, business model, O-D type, etc.
• Effect of fuel price hedging
• Test in other countries

Thank you!
Wadud (2015) Imperfect reversibility of
aviation demand: Effects of fuel prices, air
fare and price transmission
z.wadud@leeds.ac.uk

Results: Reversible vs. Imperfectly Reversible
Imperfectly reversible,
asymmetry + hysteresis
Perfectly
reversible
Asymmetry only
Ymax 1.684***
Yrec 3.503***
Yrise 1.803***
Ycut 2.102*** 1.381**
Y 1.821***
Pmax -0.510***
Prec -0.052**
Prise -0.089***
Pcut 0.009 -0.063*
P -0.099***
AIC/BIC -1898.6/-1785.1 -1879.3/-1782.0 -1877.0/-1771.6

Imperfect reversibility of air transport demand - effects of air fare fuel price and price transmission

Recommended

Recommended

More Related Content

What's hot

What's hot (19)

Viewers also liked

Viewers also liked (9)

Similar to Imperfect reversibility of air transport demand - effects of air fare fuel price and price transmission

Similar to Imperfect reversibility of air transport demand - effects of air fare fuel price and price transmission (20)

More from Institute for Transport Studies (ITS)

More from Institute for Transport Studies (ITS) (20)

Recently uploaded

Recently uploaded (20)

Imperfect reversibility of air transport demand - effects of air fare fuel price and price transmission