Channel coordination with a loss-averse retailer and option contracts

Abstract

We investigate a one-period two-echelon supply chain composed of a risk-neutral supplier that produces short life-cycle products and a loss-averse retailer that orders from the supplier via option contracts and sells to end-users with stochastic demand in the selling season. When a single retail season begins, the retailer can obtain goods by purchasing and exercising call options. We derive the loss-averse retailer's optimal ordering policy and the risk-neutral supplier's optimal production policy under these conditions. In addition, we find that the loss-averse retailer may order less than, equal to, or more than the risk-neutral retailer. Further, we show that the loss-averse retailer's optimal order quantity may increase in retail price and decrease in option price and exercise price, which is different from the case of a risk-neutral retailer. Finally, we study coordination of the supply chain and show that there always exists a Pareto contract as compared to the non-coordinating contracts.