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Imperfect Reversibility of
Air Transport Demand: Effects of Air Fare, Fuel Price & Price Transmission
Zia WadudCentre for Integrated Energy Research
Institute for Transport Studies
TRB Annual Meeting, January 2015
Centre for Integrated Energy Research
Institute for Transport Studies
Background Conclusions
Results
Methodology
Objectives
Structure
Centre for Integrated Energy Research
Institute for Transport Studies
Background Conclusions
Results
Methodology
Objectives
Centre for Integrated Energy Research
Institute for Transport Studies
Background
• Air transport demand: an important planning parameter
• Traditional demand models perfectly reversible
• In practice demand could be ‘imperfectly’ reversible:
• Asymmetry and/or
• hysteresis
Centre for Integrated Energy Research
Institute for Transport Studies
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
Y
Centre for Integrated Energy Research
Institute for Transport Studies
Background
• Hysteresis: response depends on previous history
P
Q Q
P
Y
Q Q
Y
Centre for Integrated Energy Research
Institute for Transport Studies
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?
Centre for Integrated Energy Research
Institute for Transport Studies
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
Centre for Integrated Energy Research
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Background Conclusions
Results
Methodology
Objectives
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Role of price transmission?
Fuel price Ticket pricePassenger
demand
Imperfectly
reversible reversible
Imperfectly
Imperfectly reversible
Centre for Integrated Energy Research
Institute for Transport Studies
Role of price transmission?
Fuel price Ticket pricePassenger
demandReversible reversible
Imperfectly
Imperfectly reversible
Centre for Integrated Energy Research
Institute for Transport Studies
Role of price transmission?
Fuel price Ticket pricePassenger
demand
Imperfectly
reversible Reversible
Imperfectly reversible
Reversibility in
price transmissionReversibility in
Behavioural response
Objective
• Is air transport demand imperfectly reversible wrt air fare?
• Is air fare imperfectly reversible wrt jet fuel prices?
Centre for Integrated Energy Research
Institute for Transport Studies
Background Conclusions
Results
Methodology
Objectives
Centre for Integrated Energy Research
Institute for Transport Studies
Methodology
Fuel price Ticket pricePassenger
demand
Imperfectly
reversible Reversible
Imperfectly reversible
Demand Elasticityfuel price = Fare elasticityfuel price× Demand Elasticityair fare
𝑙𝑛𝐷 = 𝛼′ 𝑙𝑛𝑌 + 𝛾𝑙𝑛𝑃 + 𝜽′𝑿′ 𝑙𝑛𝐷 = 𝛼𝑙𝑛𝑌 + 𝛽𝑙𝑛𝐹𝐴𝑅𝐸 + 𝜽𝑿
Centre for Integrated Energy Research
Institute for Transport Studies
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
𝑉𝑡𝑚𝑎𝑥 = 𝑚𝑎𝑥(𝑉0, … . , 𝑉𝑡)
𝑉𝑡𝑟𝑒𝑐 = 𝑚𝑎𝑥 0, (𝑉𝑖−1
𝑚𝑎𝑥 − 𝑉𝑖−1) − (𝑉𝑖𝑚𝑎𝑥 − 𝑉𝑖)
𝑡
𝑖=0
𝑉𝑡𝑐𝑢𝑡 = 𝑚𝑖𝑛 0, (𝑉𝑖−1
𝑚𝑎𝑥 − 𝑉𝑖−1) − (𝑉𝑖𝑚𝑎𝑥 − 𝑉𝑖)
𝑡
𝑖=0
Historical maximum
Recovery/rise,
below maximum
Fall/cut
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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
Fuel
pri
ce a
nd
its
dec
om
po
siti
on
(in
log)
Time
fuel price - recovery seriesfuel price - cut seriesfuel 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
Jan-79 Jan-82 Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09 Jan-12
Air
fare
an
d it
s d
eco
mp
osi
tio
n (i
n lo
g)
Time
air fare - recovery seriesair fare - cut seriesair fare (right axis)air fare-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
Jan-79 Jan-82 Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09 Jan-12
Inco
me
and
its
dec
om
po
siti
on
(in
log)
Time
per capita income - recovery seriesper capita income - cut seiresper capita income (right axis)per capita income-maximum series (right axis)
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Methodology: Model Specification
𝑅𝑃𝐸𝑁𝑡𝑐𝑑 = 𝜇 + 𝛼𝑚𝑎𝑥 𝑌𝑡
𝑚𝑎𝑥 + 𝛼𝑟𝑒𝑐𝑌𝑡𝑟𝑒𝑐 + 𝛼𝑐𝑢𝑡 𝑌𝑡
𝑐𝑢𝑡 + 𝛾𝑚𝑎𝑥 𝑃𝑡𝑚𝑎𝑥 + 𝛾𝑟𝑒𝑐 𝑃𝑡
𝑟𝑒𝑐 + 𝛾𝑐𝑢𝑡 𝑃𝑡𝑐𝑢𝑡
+ 𝜅𝑈𝑡 + 𝜆𝑗𝐷𝑗𝑡
4
𝑗=1+ 𝜑𝑘𝑀𝐷𝑘𝑡
12
𝑘=2+ 𝛾𝑖𝑅𝑃𝑀𝑡−𝑖
𝑐𝑑𝑙
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
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Background Conclusions
Results
Methodology
Objectives
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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
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Results: Tests for Reversibility
Hypothesis Test restrictions F-stat
Fare model
F-stat
Price model
Imp. rev.: Income αmax = αrec = αcut18.63*** 9.78***
Asymmetry: Income αrec = αcut8.03*** 11.67***
Asymmetry: Income αmax = αcut14.53*** 0.18
Hysteresis: Income αmax = αrec33.17*** 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***
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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
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Background Conclusions
Results
Methodology
Objectives
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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
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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?
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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
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Thank you!
Wadud (2015) Imperfect reversibility of
aviation demand: Effects of fuel prices, air
fare and price transmission
Centre for Integrated Energy Research
Institute for Transport Studies
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