Orders and inventory commodities with price and demand uncertainty in complete markets

Research output: Contribution to journalArticle

Abstract

The purpose of this paper is to price an order (inventory control) policy when both the demand and the price are uncertain and markets are complete. Inventory management is assumed to be equivalent to an investment for future and risky prospects for which a risk premium is required. Optimization of this risk premium defines the optimal-order policy. A number of examples are solved and we show how a zero-inventory policy can be replicated by a portfolio of options and of course an optimal-order quantity. The approach developed in this paper underlies as well a common practice by certain firms who use materials that are traded in speculative financial markets. In these situations, managers combine their production-based activities with speculations regarding their potential demand and the associated price of materials. For demonstration purposes and to highlight the practicality of this approach an extensive application and numerical results are used. In particular, we consider a two-period problem with an exponential utility function and a mean exponential demand, which is a function of price.

Original languageEnglish (US)
Pages (from-to)12-18
Number of pages7
JournalInternational Journal of Production Economics
Volume115
Issue number1
DOIs
StatePublished - Sep 2008

Fingerprint

Inventory control
Managers
Demonstrations
Uncertainty
Commodities
Demand uncertainty
Complete markets
Price uncertainty
Financial markets
Risk premium
Inventory policy
Inventory management
Utility function
Order quantity
Exponential utility
Speculation

Keywords

  • Finance
  • Inventory
  • Market pricing
  • Orders management

ASJC Scopus subject areas

  • Economics and Econometrics
  • Industrial and Manufacturing Engineering

Cite this

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abstract = "The purpose of this paper is to price an order (inventory control) policy when both the demand and the price are uncertain and markets are complete. Inventory management is assumed to be equivalent to an investment for future and risky prospects for which a risk premium is required. Optimization of this risk premium defines the optimal-order policy. A number of examples are solved and we show how a zero-inventory policy can be replicated by a portfolio of options and of course an optimal-order quantity. The approach developed in this paper underlies as well a common practice by certain firms who use materials that are traded in speculative financial markets. In these situations, managers combine their production-based activities with speculations regarding their potential demand and the associated price of materials. For demonstration purposes and to highlight the practicality of this approach an extensive application and numerical results are used. In particular, we consider a two-period problem with an exponential utility function and a mean exponential demand, which is a function of price.",
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