Strategic Analyses of Applying an Option-Based Hedging Mechanism in Parallel Airline Alliances

Abstract

The extant literature proposes an option-based hedging mechanism for airlines in a parallel alliance to transfer bumped passengers to their alliance partner's flight. This paper extends this literature by conducting strategic analyses and developing a two-stage simulation-based algorithm to identify the best strategy for applying the hedging mechanism. Specifically, the best strategy refers to the best number of options for the allied carriers to transact. The authors show that there exists a robust result of the best number of options, and it is obtained under the objective of maximizing alliance-wide revenue. The result of this paper can provide direct guidance to the management of airlines on the best practice of hedging ex-post overbooking risks and matching supply with demand.