Risk Aversion in Inventory Management

Xin Chen (), Melvyn Sim (), David Simchi-Levi () and Peng Sun ()
Additional contact information
Xin Chen: Department of Industrial and Enterprise Systems Engineering, University of Illinois at Urbana--Champaign, Urbana, Illinois 61801
Melvyn Sim: Singapore-MIT Alliance and NUS Business School, National University of Singapore, Singapore
David Simchi-Levi: Department of Civil and Environmental Engineering and Engineering System Division, Massachusetts Institute of Technology, Cambridge, Massachusetts 02139
Peng Sun: Fuqua School of Business, Duke University, Durham, North Carolina 27708

Operations Research, 2007, vol. 55, issue 5, 828-842

Abstract: Traditional inventory models focus on risk-neutral decision makers, i.e., characterizing replenishment strategies that maximize expected total profit, or equivalently, minimize expected total cost over a planning horizon. In this paper, we propose a framework for incorporating risk aversion in multiperiod inventory models as well as multiperiod models that coordinate inventory and pricing strategies. We show that the structure of the optimal policy for a decision maker with exponential utility functions is almost identical to the structure of the optimal risk-neutral inventory (and pricing) policies. These structural results are extended to models in which the decision maker has access to a (partially) complete financial market and can hedge its operational risk through trading financial securities. Computational results demonstrate that the optimal policy is relatively insensitive to small changes in the decision-maker's level of risk aversion.

Keywords: inventory/production; policies; uncertainty; decision analysis; risk (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (93)

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