An option-based hedging mechanism for managing the risk of overbooking in parallel airline alliances

• A mechanism for airline alliance to reduce ex post overbooking risk is proposed.
• An analytical model is built to calculate the net benefit of the mechanism.
• The alliance will enjoy positive net benefit by adopting the mechanism.
• Factors affecting the effectiveness of the mechanism are examined and experimented.

In the context of parallel alliances, this paper proposes and describes an option-based mechanism that allows an airline to transfer bumped passengers to its alliance partner’s flight. The objective of this mechanism is to reduce the overbooking risk borne by the allied airlines. An analytical model is built to calculate the net benefit that can be obtained by the airlines. The simulation results confirm that the proposed mechanism can generate monetary and non-monetary benefits for allied carriers under many practical conditions.