Risk hedging for VaR-constrained newsvendors

Abstract

Risk management significantly impacts the efficiency of business operations. We examine the effects of corporate risk preference on optimal ordering and risk-hedging decisions under a value-at-risk (VaR) constraint from short-term (only demand is uncertain) and long-term (both demand and supply are uncertain) perspectives. We find that under the short-term view, the impact of the shortage cost on the optimal order quantity is weaker than that of the unit net residual value. Moreover, managers can achieve a balanced management of profit and risk by using inventory to maximize profit and selecting the right option to hedge risk. Specifically, risk-averse firms can manage risk by selling a sufficient number of put options with a low enough strike price. On the other hand, risk-seeking firms should sell an adequate number of call options with a high enough strike price to meet the VaR constraint. In the long-run, we broaden the scope of applying optimal risk-hedging strategies for firms with different risk preferences. The optimal risk-hedging strategies within a specific range will be consistent with short-term ones. Otherwise, any option that satisfies the VaR constraint can be used to control risk. Our results enrich the literature on profit-risk hedging and ordering decisions based on the newsvendor model with the VaR constraint. They also help firms manage their inventories and control risk simultaneously. It is of great value to firms that are not only interested in short-term benefits but are more focused on the long-term increase in firms’ value.