Comparing validity of risk measures on newsvendor models in open innovation perspective

Sungyong Choi,Sang-Oh Shim,Kyungbae Park

doi:10.1186/s40852-017-0078-8

Abstract

In the era of Industry 4.0, firms are facing with greater uncertainty. Accordingly, it is important to select quality risk measures to analyze newsvendor problems under risk. Then, open innovation can be a good remedial option for such risk-averse newsvendors because open innovation can offset the profit losses from risk aversion by sharing revenues in supply chains. To find such risk measures in newsvendor problems, we review various risk measures of risk-averse inventory models and existing articles in inventory management literature. Then we provide a logical reasoning and axiomatic framework to evaluate validity of each risk measure in newsvendor problems - consistency to the four axioms in coherent risk measures. In this framework, the underlying assumptions and managerial insights to the newsvendor problems are examined for each risk measure. Consequently, exponential utility function and coherent measures of risk are selected as two plausible risk measures to analyze multi-product risk-averse newsvendor models.

Highlights

In the era of Industry 4.0, firms are facing with greater uncertainty
An exponential utility function and coherent risk measures are selected as two quality risk measures for newsvendor problems
It is natural that the newsvendors are risk-averse when they are in a preliminary transition stage to open innovation

Summary

Introduction

In the era of Industry 4.0, firms are facing with greater uncertainty. we cannot always expect that similar outcomes may be repeated in random situations. Many authors have pointed out that the mean-variance and mean-standard deviation models are, in general, not consistent with stochastic dominance rules, nor the Monotonicity axiom Because both models consider overperformance and under-performance they are not so-called downside risk measures and may lead to an optimal solution which is stochastically dominated by another solution. Choi et al (2011) provide a numerical example where they compare solutions of a single-product newsvendor model with coherent measures of risk, exponential utility function and mean-variance. They initially select parameters in each risk measure so that they have the same optimal solution when the unit of profit is measured as one dollar. Considering relative advantages and disadvantages of using each type risk measure, exponential utility function approach and coherent measures of risk are two plausible risk measures to analyze newsvendor model by the consideration with the axiomatic approach

Conclusion

Funding Not applicable