Monday, April 25, 2011

Option Contracts

Blog readers may be interested in reading Rolf Hellerman et al.'s new working paper, Option Contracts with Overbooking in the Air Cargo Industry (WHO Mgmt Working Paper No. 2011-PROD-2, Apr. 2011) (available from SSRN here).  From the abstract:

In today’s world economy, which is marked by increasing international trade, air cargo acts as a key facilitator. However, cargo airlines continue to struggle to be profitable because of very high asset costs and substantial demand uncertainty. To improve upon this situation, we propose an options contract. Our model captures the main features of cargo trade between an airline and a freight forwarder and allows to derive an optimal reservation policy. We then go on to analyze the impact of overbooking on the profit of the cargo capacity provider. The model is subsequently applied to real-life booking data provided by a major cargo carrier. This enables us to compare current contractual arrangements with the ones proven optimal in the model. Managerial insights to be drawn conclude this study.

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