Integrated Production Planning and Risk Hedging

Abstract

We study production planning integrated with risk hedging. In addition to using a one-time production quantity decision, made at the beginning of a planning horizon, as a way to manage demand uncertainty, we illustrate how to construct and execute a hedging strategy throughout the horizon, as a better and more effective approach to mitigating the risks involved. Furthermore, whereas traditional production planning models focus on the expected net-profit as an objective function, we study two risk measures, variance and shortfall. In both cases, we characterize the efficient frontier, and demonstrate the improved risk-return profile over a production-only decision.