Trade credit insurance, capital constraint, and the behavior of manufacturers and banks

Trade credit insurance, capital constraint, and the behavior of manufacturers and banks

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Article ID: iaor20162258
Volume: 240
Issue: 2
Start Page Number: 395
End Page Number: 414
Publication Date: May 2016
Journal: Annals of Operations Research
Authors: , ,
Keywords: manufacturing industries, game theory, optimization, finance & banking
Abstract:

The manufacturer who is a supplier of trade credit may face non‐payment risk from customers and a capital shortage problem simultaneously. Trade credit insurance, as one of the most important risk management tools, has been widely used in companies’ daily operation. In this study, the manufacturer who allows customers to delay payment for goods already delivered purchases trade credit insurance to transfer and reduce non‐payment risk and borrows money from a bank to accommodate the capital constraint problem. The Stackelberg game and loss‐averse theory are used to establish a newsboy model including trade credit insurance, and the optimal insurance coverage and total sales of the manufacturer are thereby investigated. Subsequently, the interest rate decision of the bank under different risk‐averse situations is also characterized. We find that the interest rate set by a loss‐averse bank is equal to or greater than that given by a risk‐neutral bank. The use of trade credit insurance can help the manufacturer expand sales and dramatically reduce its default risk. Both the bank and the manufacturer are better off due to the use of trade credit insurance, but contrary to what one might expect, the bank prefers giving a higher interest rate to the manufacturer when the premium rate is in a reasonable region, which indicates that the manufacturer cannot use the insurance to negotiate better financing terms.

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