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Article: How Does Risk Hedging Impact Operations? Insights from a Price-setting Newsvendor Model

TitleHow Does Risk Hedging Impact Operations? Insights from a Price-setting Newsvendor Model
Authors
Issue Date17-Apr-2023
PublisherInstitute for Operations Research and Management Sciences
Citation
Management Science, 2023 How to Cite?
Abstract

If a financial asset’s price movement impacts a firm’s product demand, the firm can respond to the impact
by adjusting its operational decisions. For example, in the automotive industry, car makers decrease the
selling prices of fuel-inefficient cars when the oil price rises. Meanwhile, the firm can implement a risk-hedging strategy using the financial asset jointly with its operational decisions. Motivated by this, we develop and solve a general risk-management model integrating risk hedging into a price-setting newsvendor. The optimal hedging strategy is calculated analytically, which leads to an explicit objective function for optimizing price and “virtual production quantity” (VPQ). (The latter determines the service level, i.e., the demand fulfillment probability.) We find that hedging generally reduces the optimal price when the firm sets the target mean return as its production-only maximum expected profit. With the same condition on the target mean return, hedging also reduces the optimal VPQ when the asset price trend positively impacts product demand; meanwhile, it may increase the VPQ by a small margin when the impact is negative. We construct the return-risk efficient frontier that characterizes the optimal return-risk trade-off. Our numerical study using data from a prominent automotive manufacturer shows that the markdowns in price and reduction in VPQ are small under our model and that the hedging strategy substantially reduces risk without materially reducing operational profit.


Persistent Identifierhttp://hdl.handle.net/10722/337121
ISSN
2023 Impact Factor: 4.6
2023 SCImago Journal Rankings: 5.438

 

DC FieldValueLanguage
dc.contributor.authorWang, Liao-
dc.contributor.authorYao, Jin-
dc.contributor.authorZhang, Xiaowei-
dc.date.accessioned2024-03-11T10:18:16Z-
dc.date.available2024-03-11T10:18:16Z-
dc.date.issued2023-04-17-
dc.identifier.citationManagement Science, 2023-
dc.identifier.issn0025-1909-
dc.identifier.urihttp://hdl.handle.net/10722/337121-
dc.description.abstract<p>If a financial asset’s price movement impacts a firm’s product demand, the firm can respond to the impact<br>by adjusting its operational decisions. For example, in the automotive industry, car makers decrease the<br>selling prices of fuel-inefficient cars when the oil price rises. Meanwhile, the firm can implement a risk-hedging strategy using the financial asset jointly with its operational decisions. Motivated by this, we develop and solve a general risk-management model integrating risk hedging into a price-setting newsvendor. The optimal hedging strategy is calculated analytically, which leads to an explicit objective function for optimizing price and “virtual production quantity” (VPQ). (The latter determines the service level, i.e., the demand fulfillment probability.) We find that hedging generally reduces the optimal price when the firm sets the target mean return as its production-only maximum expected profit. With the same condition on the target mean return, hedging also reduces the optimal VPQ when the asset price trend positively impacts product demand; meanwhile, it may increase the VPQ by a small margin when the impact is negative. We construct the return-risk efficient frontier that characterizes the optimal return-risk trade-off. Our numerical study using data from a prominent automotive manufacturer shows that the markdowns in price and reduction in VPQ are small under our model and that the hedging strategy substantially reduces risk without materially reducing operational profit.<br></p>-
dc.languageeng-
dc.publisherInstitute for Operations Research and Management Sciences-
dc.relation.ispartofManagement Science-
dc.titleHow Does Risk Hedging Impact Operations? Insights from a Price-setting Newsvendor Model-
dc.typeArticle-
dc.description.naturepreprint-
dc.identifier.eissn1526-5501-
dc.identifier.issnl0025-1909-

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