Production and inventory dynamics under ambiguity aversion

Yulei Luo, Jun Nie, Xiaowen Wang and Eric R. Young

Journal of Monetary Economics, 2025, vol. 152, issue C

Abstract: In this paper we propose a production-cost smoothing model with Knightian uncertainty and ambiguity aversion to study the joint behavior of production, inventories, and sales. Our model can explain ten facts that previous studies find difficult to account for simultaneously including the high volatility of production relative to sales, the low ratio of inventory-investment volatility to sales volatility, the positive correlation between sales and inventory investment, and the negative correlation between the inventory-to-sales ratio and sales. Our main results extend to a model of endogenous sales. Finally, we find that the stock-out avoidance motive emerges endogenously in our model, reconciling the long debate in the inventory literature over the production-cost smoothing and stock-out avoidance models.

Keywords: Ambiguity aversion; Knightian uncertainty; Inventories; Production-cost smoothing (search for similar items in EconPapers)
JEL-codes: D83 E21 F41 G15 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:152:y:2025:i:c:s0304393225000388

DOI: 10.1016/j.jmoneco.2025.103767

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