Article ID: | iaor20082877 |
Country: | United States |
Volume: | 55 |
Issue: | 5 |
Start Page Number: | 828 |
End Page Number: | 842 |
Publication Date: | Sep 2007 |
Journal: | Operations Research |
Authors: | Simchi-Levi David, Chen Xin, Sim Melvyn, Sun Peng |
Keywords: | risk |
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.