A risk-averse and buyer-led supply chain under option contract: CVaR minimization and channel coordination

Abstract

Option contracts are used commonly in business to tackle difficulties in working capital shortage and hedge market risks. In this paper, we consider option contract application in a buyer-led supply chain, where both the buyer and supplier are risk-averse. The effects of option price and option exercise price are investigated via conditional value-at-risk (CVaR) minimization. A Stackelberg game model is established to examine the influences of adjusting both prices on the benefits and risks at the buyer and supplier sides. We find that the increase of both prices, especially the increase of option price, benefits the supplier but causes loss to the buyer. The supply chain's total risk is not affected by either price when the buyer and supplier have the same risk preference. However, when the supplier raises the option price, the buyer who is more risk-averse will bear extra risk more than the supplier's reduced risk. A numerical study shows that the option exercise price has an opposite effect on the supply chain. We theoretically prove that when the supplier's risk preference is the same as or larger than that of the buyer, the supply chain can be coordinated under option contract; otherwise, the supply chain cannot be coordinated.