The Effects of Financial Risks on Inventory Policy
Management Science · 2005 · Volume 51 · Issue 12
Abstract
The effect of financial risks on ( R, Q ) inventory policies is analyzed in a real options framework. Simple adjustments of the usual formulas for R and Q are suggested and tested. Stochastic demand and purchase costs are considered, both with known systematic (business-cycle-related) risk. The systematic risk of stochastic demand has typically a negligible effect on the optimal values of R and Q , although an improvement may be achieved by a simple adjustment of R . The systematic risk of the purchase price, c , has a significant effect on R and Q . The capital holding cost should be estimated as r · c , where r is the sum of the risk-free interest rate, the expected price decrease, and the risk premium associated with the systematic risk of c . For goods quoted on commodity exchanges, r may be estimated directly from the prices on forward contracts. Its size (and sign) varies considerably for different commodities.
Keywords
inventory control, inventory costing, capital cost and real options
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