Airfares and oil prices: ‘Feathers and Rockets’ adjustments

Abstract

One reason that the US Department of Justice is examining collusion within the airline industry may be the small (12%) decline in airfares that follows a large (57%) drop in crude oil prices. This relatively small response could be caused by three mechanisms related to the oil market; (1) slow rates of adjustment, (2) airfares adjust asymmetrically to changes in the oil market, or (3) asymmetric adjustments within the oil market that are communicated symmetrically to airfares. I evaluate these hypotheses by estimating a cointegrating vector autoregression model from monthly data and testing the error correction mechanism for asymmetry. Although small, estimated rates of adjustment indicate that the large reduction in oil prices has been passed to airfares. Tests of the error correction model do not provide evidence for asymmetric adjustments between airfares and oil market. Contrary to the relation between crude oil and motor gasoline prices, prices for jet fuel adjust faster to reductions in crude oil prices and so cannot be responsible for the relatively small decline in airfares. Although the CVAR model does not identify an oil-related mechanism that can generate the small decline in airfares relative to the large decline in the price for crude oil, this absence does not imply the converse, that airlines collude to set airfares.