Optimal Strategies Using Financial Options in Airline Booking

Open Access
Ravelojaona, Eve
Graduate Program:
Industrial Engineering
Master of Science
Document Type:
Master Thesis
Date of Defense:
Committee Members:
  • M Jeya Chandra, Thesis Advisor
  • airline industry
  • revenue management
  • airline booking
  • options theory
  • optimization
Maximizing airline profit is challenging as several costs, such as fuel or manpower, have been increasing. Fierce competition has forced airlines to drastically reconsider their economic policy. Traditionally, revenue management techniques such as overbooking or dynamic pricing have been utilized to improve profit of the airline industry. Recently, the use of financial options theory offers a different approach to airline revenue maximization. The purpose of this thesis is to apply financial option theory in order to maximize the expected revenue of the airline per flight. An option-based model to maximize the airline revenue under uncertainty and a numerical search method are presented. The demand distribution and the random walk of a ticket price cause uncertainty in the booking process. The proposed model assumes that the evaluation periods are discrete and uses the Cross-Ross-Rubinstein model (1979) to price the options. The complexity of the expected revenue expression does not allow for the utilization of calculus to maximize the airline’s profit. Therefore, a numerical search method is used to determine the optimal values for the decisions variables, which are the initial number of call and put options and the respective strike prices, for a given distribution of demand. A numerical example is presented and sensitivity analysis is performed to test the behavior of the model when changing input parameters (skewness of demand distribution and up and down moves of the ticket price). It is found that changing the skewness of the distribution has a significant effect on the expected revenue. Moreover, we show that the parameters of the random walk (the drift and its variance) directly affect the utilization of options, because these have a direct effect on the probability that the ticket price increases. Our analysis demonstrates the importance of accurate forecasting of demand and the precise estimation of the random walk parameters.