Risk aversion in inventory management

Published

Journal Article

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. © 2007 INFORMS.

Full Text

Duke Authors

Cited Authors

  • Chen, X; Sim, M; Simchi-Levi, D; Sun, P

Published Date

  • September 1, 2007

Published In

Volume / Issue

  • 55 / 5

Start / End Page

  • 828 - 842

Electronic International Standard Serial Number (EISSN)

  • 1526-5463

International Standard Serial Number (ISSN)

  • 0030-364X

Digital Object Identifier (DOI)

  • 10.1287/opre.1070.0429

Citation Source

  • Scopus