Hedging demand and supply risks in the newsvendor model

Abstract

We consider a single-period inventory model where there are risks associated with the uncertainty in demand as well as supply. Furthermore, the randomness in demand and supply is correlated with the financial markets. Recent literature provides ample evidence on this issue. The inventory manager may then exploit this correlation and manage his risks by investing in a portfolio of financial instruments. The decision problem, therefore, includes not only the determination of the optimal ordering policy, but also the selection of the optimal portfolio at the same time. We analyze this problem in detail and provide a risk-sensitive approach to inventory management where one considers both the mean and the variance of the resulting cash flow. The analysis results in some interesting and explicit characterizations on the structure of the optimal policy.

Mean-Variance Newsvendor Model with Random Supply and Financial Hedging

“…Finally, derivations of some of the results and proofs are presented in the Appendix. Our work is closely related to Okyay et al (2014) andOkyay et al (2011b) who use the expected cash flow maximization, and Sayın et al (2014) who uses the expected utility maximization framework. They follow a two-step approach.…”

“…Okyay et al (2011b), we consider three types of financial portfolios in our analysis.The first portfolio consists of futures only and has the net payoff f 1 (S ), the second portfolio consists of the call option with strike price κ = y/b and has the net payoff f 2 (S ). Finally, the third portfolio uses both instruments jointly and has the net payoffs f 1 (S ) and f 2 (S ).…”

Optimal inventory policy through dual sourcing

“…Instead of creating an optimal inventory re-ordering policy, various researchers attempted to oset the operational risk through nancial hedging. Uncertainty, not only in product supply, but also in consumer demand was researched by [Okyay et al, 2014]. Their approach attempts to mitigate the negative product supply and consumer demand factors by investing in a portfolio of nancial assets -stating that there is a correlation between the uncertainty in the inventory model and the nancial market.…”