Empirics of Air Services Agreements: A Structural Model of Network Formation

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Coauthor:  Phillip McCalman, University of Melbourne

Abstract:

Air services agreements are necessary for direct flights between countries and consequently are central to the operation of the international commercial airline market. These agreements are bilateral in nature but their coverage is far from universal. To gain insight into why some agreements are signed but not others, we study a new data set on air services agreements from the perspective of strategic network formation. Since the signing of an agreement can have implications for countries other than the two directly involved, this is an environment where  externalities are likely to be important. These externalities also suggest that there are multiple equilibria for any candidate set of parameters, creating a fundamental identification problem for any econometric analysis.  To address this issue we develop a structural model based on moment inequalities that uses the concepts of pairwise stability to generate estimating equations and also introduce methods to implement refinements of pairwise stability. The network structure is found to be important in determining the choices of countries to form agreements, and that the jointly optimal network of agreements would be substantially different than the observed outcome.