An Option Pricing Approach for Evaluating the Agency Problem of Jump Risk between Airlines and Travel Agents

Abstract

The authors address the agency problem of jump risk between industries with the proposed Agency Jump Risk Option Pricing (AJROP) model. In the model, the option pricing approach is applied to the evaluation of this problem between companies and their agencies. Under the AJROP model, the agency cost can be regarded as the premium of an option. For some industries, the incentive programmes provided for a company's agencies endow the option with a path-dependent barrier option feature. Among these industries, airlines have long been suffering from catastrophic aviation events which usually cause shocks to the price and quantity of airline tickets. Under the AJROP model, the ticket price, ticket quantity and jump risk stochastic processes are well-defined. The authors show that the stochastic variable parameters, the jump risk parameters and incentive programmes influence the agency cost significantly. Companies should therefore design their incentive programmes cautiously by considering the key underlying variables so as to reduce the impacts caused by the agency problem.