Output Decision Under Demand Uncertainty with Stochastic Production Function: A Contingent Claims Approach

Kee H. Chung
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Kee H. Chung: Department of Finance, Fogelman College of Business and Economics, Memphis State University, Memphis, Tennessee 38152

Management Science, 1990, vol. 36, issue 11, 1311-1328

Abstract: This paper presents a contingent claims analysis of output decisions for the firm facing technological and demand uncertainty. The paper reveals that: (i) the optimal output level increases with the higher interest rate when the firm is subject to demand (and technological) uncertainty; (ii) the effect of demand volatility and production lead time on the optimal output level could be either positive or negative; (iii) the optimal project value decreases with the higher demand volatility; (iv) the optimal project value decreases with the longer production lead time when the firm is subject to demand uncertainty; and (v) the optimal project value decreases with the higher interest rate when the firm is subject to demand uncertainty; it increases with the higher interest rate, however, when the firm is subject to both demand and technological uncertainty. Some important managerial implications are discussed.

Keywords: output decision; contingent claims analysis; uncertainty (search for similar items in EconPapers)
Date: 1990
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Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:36:y:1990:i:11:p:1311-1328

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