The effects of financial risks on inventory policy

The effects of financial risks on inventory policy

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Article ID: iaor2008628
Country: United States
Volume: 51
Issue: 12
Start Page Number: 1804
End Page Number: 1815
Publication Date: Dec 2005
Journal: Management Science
Authors: ,
Keywords: risk
Abstract:

The effect of financial risks on (R, Q) inventory policies is analyzed in a real options framework. Simple adjustments of the usual formulas for R and Q are suggested and tested. Stochastic demand and purchase costs are considered, both with known systematic (business-cycle-related) risk. The systematic risk of stochastic demand has typically a negligible effect on the optimal values of R and Q, although an improvement may be achieved by a simple adjustment of R. The systematic risk of the purchase price, c, has a significant effect on R and Q. The capital holding cost should be estimated as r · c, where r is the sum of the risk-free interest rate, the expected price decrease, and the risk premium associated with the systematic risk of c. For goods quoted on commodity exchanges, r may be estimated directly from the prices on forward contracts. Its size (and sign) varies considerably for different commodities.

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