Asymmetric Price Adjustments in Airlines

Escobari, Diego (2012): Asymmetric Price Adjustments in Airlines.

Abstract

This paper uses a unique daily time series data set to investigate the asymmetric response of airline prices to capacity costs driven by demand fluctuations. We use a Markov regime-switching model with time-varying transition probabilities to capture the time variation in the response. The results show strong evidence of asymmetric price adjustments: positive cost shifts have a large positive effect, while negative cost shifts have no effect. The asymmetry is also explained by summer travel, but not by the size of cost shifts. The findings show the importance of consumer heterogeneity and capacity constraints as a source of asymmetric responses.

• Item Type: MPRA Paper
• Language: English
• Keywords: Asymmetric pricing; Airlines; Regime switching; Capacity costs
• Subjects: L - Industrial Organization > L9 - Industry Studies: Transportation and Utilities > L93 - Air Transportation; C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes

References

Alderighi, M., M. Nicolini, and C.A. Piga, 2012. Combined Effects of Load Factors and Booking Time on Fares: Insights from the Yield Management of a Low-Cost Airline. FEEM Working Paper.

Athey, S., K. Bagwell and C. Sanchirico, 2004. Collusion and price rigidity. Review of Economic Studies 71, 317-349.

Ball, L. and N.G. Mankiw, 1994. Asymmetric price-adjustment and economic fluctuations. The Economic Journal 104, 247-261.

Bachmeier, L.J. and J.M. Griffin, 2003. New evidence on asymmetric gasoline price responses. Review of Economics and Statistics 85, 772-776.

Bilotkach, V., 2006. Understanding price dispersion in the airline industry: Capacity constraints and consumer heterogeneity. In Advances in Airline Economics, Vol. 1, edited by Darin Lee. New York: Elsevier Sci.

Bilotkach, V. and N. Rupp, 2011. A guide to booking airline tickets online. mimeo. University of California, Irvine.

Borenstein, S. and N.L. Rose, 1994. Competition and price dispersion in the U.S. airline industry. Journal of Political Economy 102, 653-683.

Borenstein, S., C.A. Cameron and R. Gilbert, 1997. Do gasoline prices respond asymmetrically to crude oil price changes? Quarterly Journal of Economics 112, 305-339.

Busse, M., 2002. Firms financial condition and airline price wars. Rand Journal of Economics 33, 298-318.

Cabral, L. and A. Fishman, 2012. Business as usual: A consumer search theory of sticky prices and asymmetric price adjustment. International Journal of Industrial Organization, Forthcoming.

Dana, Jr. J.D., 1999. Equilibrium price dispersion under demand uncertainty: The roles of costly capacity and market structure. Rand Journal of Economics 30, 632-660.

Davis, M.C., 2007. The dynamics of daily retail gasoline prices. Managerial and Decision Economics 28, 713-722.

Deneckere, R. and J. Peck, 2012. Dynamic competition with random demand and costless search: A theory of price posting. Econometrica 80, 1185-1247.

Enders, W. and C.W.J. Granger, 1998. Unit-root tests and asymmetric adjustment with an example using the term structure of interest rates. Journal of Business and Economic Statistics 16, 304-311.

Escobari, D., 2009. Systematic peak-load pricing, congestion premia and demand diverting: Empirical evidence. Economics Letters 103, 59-61.

Escobari, D., 2012. Dynamic pricing, advance sales, and aggregate demand learning in airlines. Journal of Industrial Economics, Forthcoming.

Escobari, D. and L. Gan, 2007. Price dispersion under costly capacity and demand uncertainty. NBER working paper 13075, Cambridge, MA.

Filardo, A.J., 1994. Business-cycle phases and their transitional dynamics. Journal of Business and Economics Statistics 12, 299-308.

Gaggero, A.A. and C.A. Piga, 2011. Airline market power and intertemporal price dispersion. Journal of Industrial Economics 59, 552-577.

Gerardi, K.S. and A.H. Shapiro, 2009. Does competition reduce price dispersion? New evidence from the airline industry. Journal of Political Economy 117, 1-37.

Goodwin, B.K. and M.T. Holt, 1999. Price transmission and asymmetric adjustment in the U.S. beef sector. American Journal of Agricultural Economics 81, 630-637.

Hamilton, J.D., 1989. A new approach to the economic analysis of nonstationary time series and the business cycle. Econometrica 57, 357-384.

Hansen, B.E., 1992. The likelihood ratio test under nonstandard conditions: Testing the Markov switching model of GNP. Journal of Applied Econometrics 7, S61-S82.

Hayes, K.J. and L.B. Ross, 1998. Is airline price dispersion the result of careful planning or competitive forces? Review of Industrial Organization 13, 523-541.

Kim, C-J., 1994. Dynamic linear models with Markov-switching. Journal of Econometrics 60, 1-22.

Lewis, M.S., 2011. Asymmetric price adjustment and consumer search: An examination of the retail gasoline market. Journal of Economics and Management Strategy 20, 409-449.

Lo, M.C. and J. Piger, 2005. Is the response of Output to monetary policy asymmetric? Evidence from a regime-switching coefficients model. Journal of Money, Credit, and Banking 37, 865-886.

McAfee, R.P. and V. te Velde, 2007. Dynamic pricing in the airline industry. In Handbook of Economics and Information Systems, vol. 1, edited by T.J. Hendershott. New York: Elsevier Sci.

Meyer, J. and S. von Cramon-Taubadel, 2004. Asymmetric price transmission: a survey. Journal of Agricultural Economics 55, 581-611.

Muller, G. and S. Ray, 2007. Asymmetric price adjustment: evidence from weekly product-level scanner price data. Managerial and Decision Economics 28, 723-736.

Noel, M.D., 2008. Edgeworth Price Cycles and Focal Prices: Computational Dynamic Markov Equilibria. Journal of Economics and Management Strategy 17, 345-377.

Peltzman, S., 2000. Prices rise faster than they fall. Journal of Political Economy 108, 466-502.

Prescott, E., 1975. Efficiency of the natural rate. Journal of Political Economy 83, 1229-1236.

Staiger, R.W. and F.A. Wolak, 1992. Collusive pricing with capacity constraints in the presence of demand uncertainty. Rand Journal of Economics 23, 203-220.

Stavins, J., 2001. Price discrimination in the airline market: The effect of market concentration. The Review of Economics and Statistics 83, 200-202.

Tappata, M., 2009. Rockets and feathers: Understanding asymmetric pricing. Rand Journal of Economics 40, 673-687.

Toolsema, L.A. and J.P.A.M. Jacobs, 2007. Why do prices rise faster than they fall? with an application to mortgage rates. Managerial and Decision Economics 28, 701-712.

Yang, H. and L. Ye, 2008. Search with learning: understanding asymmetric price adjustments. Rand Journal of Economics 39, 547-564.

Zachmann, G. and C. von Hirschhausen, 2008. First evidence of asymmetric cost pass-through of EU emissions allowances: Examining wholesale electricity prices in Germany. Economics Letters 99, 465-469.