An economic model for evaluating mining and manufacturing ventures with output yield uncertainty

An economic model for evaluating mining and manufacturing ventures with output yield uncertainty

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Article ID: iaor20022416
Country: United States
Volume: 49
Issue: 5
Start Page Number: 690
End Page Number: 699
Publication Date: Sep 2001
Journal: Operations Research
Authors: ,
Keywords: programming: dynamic, inventory, measurement
Abstract:

This paper develops an operational risk management model for evaluating production efforts in manufacturing and mining industries where the resource to be exploited is nonhomogeneous. Using a contingent claims methodology now commonly encountered in financial applications, we formulate a production control model in an environment characterized by market and process uncertainty. In our analysis, market risk is depicted by the output price while process uncertainty is captured by the random variability inherent in the output's yield. In this light, adjustments to the rate of production are viewed as a sequence of (nested) real options affording operating flexibility. We account for an optimal sequence of production adjustments, over a preestablished production horizon, by taking the production rate as an adapted positive real-valued process. Accordingly, techniques of stochastic control theory and contingent claims analysis are employed to ensure value maximizing production policies are rendered in a manner consistent with an equilibrium price structure.

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