Inventory Risk mitigation by financial hedging

Abstract

In this paper, we study the opportunities of financial hedging to mitigate inventory risks when the demand process is correlated with the price of a financial asset. Firstly, we develop a continuously reviewed inventory model with uncertain demand and mean-variance criterion to address the financial hedging problem. Then, we propose a simple but effective strategy of financial hedging that allows a manager to exploit various financial securities as the instrument for mitigation of inventory risks. Finally, we provide a numerical experiment using Monte Carlo simulation to assess the effectiveness of the financial hedging approach.