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Mean‐variance trade‐offs in supply contracts
Author(s) -
MartínezdeAlbéniz Victor,
SimchiLevi David
Publication year - 2006
Publication title -
naval research logistics (nrl)
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.665
H-Index - 68
eISSN - 1520-6750
pISSN - 0894-069X
DOI - 10.1002/nav.20186
Subject(s) - portfolio , newsvendor model , efficient frontier , variance (accounting) , profit (economics) , purchasing , modern portfolio theory , economics , econometrics , computer science , microeconomics , supply chain , business , finance , operations management , marketing , accounting
We study the trade‐offs faced by a manufacturer signing a portfolio of long‐term contracts with its suppliers and having access to a spot market. The manufacturer incurs inventory risk when purchasing too many contracts and spot price risk when buying too few. We quantify these risks for a single selling period by studying the profit mean and variance for a given portfolio of option contracts. We characterize the set of efficient portfolios that the manufacturer must hold in order to obtain dominating mean‐variance pairs. Among these, we emphasize the maximum expectation portfolio, obtained by solving the classical newsvendor problem, and the corresponding minimum variance portfolio. We show that the upper‐level sets of a mean‐variance utility function are connected. Hence, a greedy method will find the portfolios on the efficient frontier. Finally, we provide a comparison with standard hedging strategies and show that the approximation associated with financial hedging can be relatively inaccurate. © 2006 Wiley Periodicals, Inc. Naval Research Logistics 2006