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Risk aversion, generalized correlation and investment in manufacturing capacities
Author(s) -
Callen Jeffrey L.,
Sarath Bharat
Publication year - 1995
Publication title -
journal of operations management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 3.649
H-Index - 191
eISSN - 1873-1317
pISSN - 0272-6963
DOI - 10.1016/0272-6963(95)00014-j
Subject(s) - extant taxon , product (mathematics) , investment (military) , decision maker , econometrics , correlation , value (mathematics) , economics , microeconomics , negative correlation , positive correlation , business , mathematics , statistics , medicine , geometry , management science , evolutionary biology , politics , political science , law , biology
This study analyzes the relationship between product demand correlation and risk on the investment in dedicated and flexible manufacturing capacities. It is proved that for a risk averse (or risk neutral) decision‐maker, increased generalized correlation between output demands reduces the values of both dedicated and flexible manufacturing investments for all multivariate distributions. It is shown that no such monotonic relationship generally exists for the capacities themselves because of an economic tradeoff between risk and return. It is also proved that increased generalized correlation reduces the value of flexible capacity relative to dedicated capacity for the risk‐neutral decision maker. However, contrary to the extant literature, flexible capacity is still shown to be potentially valuable even if product demands are perfectly positively correlated. Finally, it is shown that increases in the risk of product demand, holding correlation (of product demand) constant, reduces the value of the investment in manufacturing capacities when output demands are either jointly normal or independent.