Mean‐Variance Hedging for Production Planning with Multiple Products

Abstract

We study production planning in a multi‐product setting, in which demand for each product depends on multiple financial assets (such as commodities, market indices, etc). In addition to the production quantity decision at the beginning of the planning horizon, there is also a real‐time hedging decision throughout the horizon; and we optimize both decisions jointly. With a mean‐variance problem formulation, we first derive the optimal hedging strategy, given the production quantities. This leads to an explicit objective function with which bounds on optimal production quantities are identified. Thus, optimization of the production policies can be readily solved numerically as a static minimization problem. This way, we are able to give a complete characterization of the mean‐variance efficient frontier, and quantify the contribution of the hedging strategy by the variance reduction it achieves. Furthermore, the model and results are extended to allow dynamic production control that tracks the demand rates.