Risk-sharing Contract Research Articles

Risk-Sharing Contracts and risk management of bilateral contracting in electricity markets

The liberalization of the electricity sector has conducted to the establishment of spot markets, derivative markets and private bilateral contracts to trade electricity, increasing the competition in the sector. Spot markets are composed of day-ahead, intraday and real-time markets, and their prices are highly volatile. Derivative markets are composed of physical and financial products to hedge against spot price volatility. Players can set the terms and conditions of private bilateral contracts but these have several risks that can be mitigated using a risk management process composed of three phases: risk assessment, characterization and hedging. This paper focuses on both risk attitude and risk-sharing, and how they can influence the negotiation of the price. It presents the standard and non-standard designs of a new type of contract, the Risk-Sharing Contract (RSC). Furthermore, it describes the trading process of these contracts and introduces a negotiation strategy for dealing with risk. It also presents case studies on bilateral contracting involving the negotiation of RSCs, where different demand and supply agents interact and trade according to the rules of an alternating offers protocol. Results from the case studies prove the benefit of RSCs to hedging against spot price volatility, benefiting risk-averse players by reducing the price risk and conducting mutually beneficial agreements. While the use of derivatives products can conduct losses/revenues between −15% and 3% concerning the spot market, by using non-standard RSCs those outputs vary between −1% and 3% with substantially less risk.

Design of risk sharing and coordination mechanism in supply chain under demand and supply uncertainty

Perishable and short-life products can be seen everywhere in life. Due to the particularity of these products, they are more complicated in supply chain management. This paper studies whether the two-part tariff and ZRS contract can achieve the purpose of reducing risks and coordinating supply chain. We assume that market demand and supplier yield are uncertain, and we use game theory and probability distribution for research. The research results show that when the information is asymmetric, the manufacturer always ignore the demand forecast information provided by the retailer under the wholesale price contract. When the demand is uncertain, regardless of whether the information is symmetric or asymmetric, the two-part tariff contract and the ZRS contract can coordinate the supply chain and achieve maximum profit. When the retailer’s degree of risk aversion is high, the ZRS contract is better than the two-part tariff, which can reduce the risk of retailers and achieve the purpose of coordinating the supply chain. When the supply is uncertain, the manufacturer can provide the supplier with a risk-sharing contract, including the return price and the sharing ratio that meet certain constraints. Such a contract can effectively reduce the supplier’s risk and realize supply chain coordination.

Coordinating a fresh-product supply chain with demand information updating: Hema Fresh O2O platform

Motivated by Hema Fresh’s new-retail case, we study the coordination of a two-echelon fresh-product supply chain consisting of a single supplier and a single retailer. Due to a long production lead time, the supplier has to make production decision in advance based on early demand information. The market demand can be updated during the supplier’s production lead time. Hence, the retailer would make order decision according to the latest demand information. Incorporating risk-sharing mechanism of overproduction and overstock, we propose a novel bi-directional risk-sharing contract to coordinate such a supply chain with demand information updating. We construct a two-stage optimization model in which the supplier first decides production quantity, and then the retailer decides final order quantity not exceeding the supplier’s initial production. In both the centralized and decentralized systems, we analytically derive the unique equilibrium of production and order decisions in a Stackelberg supplier-led game. We prove that the proposed contract can realize supply chain perfect coordination and explore how the proposed contract affects the members’ decisions. The theoretical results show that, by turning the risk-sharing proportions, the supply chain profit can be arbitrarily split between the members, which is a desired property for supply chain coordination. Compared with the single risk-sharing contract, the proposed contract results in a greater supply chain profit and achieves Pareto improvement for both members. Furthermore, we also explore how the risk preference and negotiating power affect the contract selection and the additional profit allocation of the supply chain. Numerical examples are presented to verify our theoretical results.

Decision and Coordination in the Dual-Channel Supply Chain Considering the Risk-Averse and Customer Returns

The biggest disadvantage of online shopping is that it is impossible to accurately assess the suitability of goods prior to purchase. Customers usually check “fit” at home, and thus one third of internet sales are returned. We study the pricing and ordering of a dual-channel supply chain which composed of risk-neutral manufacturers and risk-averse retailers serving customers who differ in how they purchase products in store or online. Customers may return misfit products either to stores for a full refund or online as per the retailer’s return policy. At the beginning of the sale season, channels order from manufacturers and set prices to be identical across channels. According to the criterion of conditional value at risk (CVaR), we express the problem as a Stackelberg game model and obtain the equilibrium solution under the conditions of decentralization and centralization. Further, we explore the impact of the retailer’s risk indicator and consumer returns rate on the optimal retail price, the ordering quantities, the profits of dual channels, and the overall profits of the supply chain. We find that dual-channel supply should reduce the risk aversion level of retailers and consumer return rate. Finally, the improved risk-sharing contract is proposed to coordinate the dual-channel supply chain in the presence of customer returns and risk-averse, and it is proved that the contract can achieve Pareto improvement of supply chain members.

Managing Reputation Risk in Supply Chains: The Role of Risk Sharing Under Limited Liability

When a supplier fails to comply with social and environmental standards, the buyer’s reputation suffers. Reputation costs can typically be very high for the buyer, whereas the supplier’s liability is often limited. Conventional procurement strategies such as dual sourcing mitigate the buyer’s operational risk, but they often do so at the expense of increasing its reputation risk and sourcing costs. In this paper, we propose a risk-sharing contract for managing the buyer’s reputation concerns. We find that by sharing some of the supplier’s operational loss, the buyer may (in some conditions) decrease its reputational risk, but this has to be balanced against an increase in the operational risk. Risk sharing also reduces sourcing costs because the buyer takes on some of the worst-case loss of a wealth-constrained supplier. These results suggest that risk sharing can be superior, as a procurement strategy, to conventional approaches such as dual sourcing or penalty contracts. This is true when reputation and sourcing costs are a significant concern and operational costs are not that high. Under some conditions, the buyer may choose risk sharing even if it increases reputation risk in order to reduce procurement costs. This paper was accepted by Victor Martínez-de-Albéniz, operations management.

A mathematical model for pharmaceutical supply chain coordination: Reselling medicines in an alternative market

Leftover/end of life (EOL) medications not only cause financial losses for the pharmacy but also lead to disposal costs and high governmental penalties for the pharmaceutical supplier. In this study, a two-echelon pharmaceutical supply chain (PSC), including a single pharmaceutical supplier (pharma-supplier) and a single pharmaceutical retailer (pharmacy) with one type of fixed shelf-life medicine, is analyzed. A reducing pharmaceutical wastes scheme is developed to decrease relevant costs of leftover/EOL medicines, avoid governmental penalties, and also ensure patient service level (PSL). In the proposed model, excess medications are collected from the pharmacy warehouse based on the realized demand at a specific time before the expiration date to be resold in the secondary/alternative market. The introduced model is investigated in decentralized and centralized model structures. A novel combination of buyback and shortage risk-sharing contract (B&SRS) is proposed to attain channel coordination, maximize the whole PSC profits, and motivate members to participate in the scheme. The numerical investigation demonstrates that the proposed B&SRS contract can coordinate the developed PSC, enhance the whole channel profit, and also guarantee both channel members’ profitability. Besides, the investigated model helps pharmaceutical managers to decrease EOL/expired medicines related costs and ensure PSL by making decision properly on buyback quantity.

Bilateral Risk Sharing with Heterogeneous Beliefs and Exposure Constraints

This paper studies bilateral risk sharing under no aggregate uncertainty, where one agent has Expected-Utility preferences and the other agent has Rank-Dependent Utility preferences with a general probability distortion function. We impose exogenous constraints on the risk exposure for both agents, and we allow for any type or level of belief heterogeneity. We show that Pareto-optimal risk-sharing contracts can be obtained via a constrained utility maximization under a participation constraint of the other agent. This allows us to give an explicit characterization of optimal risk-sharing contracts. In particular, we show that an optimal risk-sharing contract contains allocations that are monotone functions of the likelihood ratio, where the latter is obtained from Lebesgue's Decomposition Theorem.

BILATERAL RISK SHARING WITH HETEROGENEOUS BELIEFS AND EXPOSURE CONSTRAINTS

AbstractThis paper studies bilateral risk sharing under no aggregate uncertainty, where one agent has Expected-Utility preferences and the other agent has Rank-dependent utility preferences with a general probability distortion function. We impose exogenous constraints on the risk exposure for both agents, and we allow for any type or level of belief heterogeneity. We show that Pareto-optimal risk-sharing contracts can be obtained via a constrained utility maximization under a participation constraint of the other agent. This allows us to give an explicit characterization of optimal risk-sharing contracts. In particular, we show that an optimal risk-sharing contract contains allocations that are monotone functions of the likelihood ratio, where the latter is obtained from Lebesgue’s Decomposition Theorem.

Dual Channel Supply Chain Coordination of Loss-Averse Newsvendor and Pre-sale Mode with Contract

This paper takes the dual-channel supply chain as the research background. Online supply adopts pre-sale strategy, while offline supply adopts inventory strategy and faces the newsvendor problem. The retailer is loss averse. We consider the decentralized decision making and retailer decision making and deduce the correlations between order quantity, price deviation and loss aversion. By the numerical analysis, we observed that the loss-aversion of retailer will make the members of the supply chain suffer losses. At last, we have verified that manufacturers cannot coordinate the supply chain with buyback contract. Furthermore, we achieve this goal with GLB which is an improved risk-sharing contract based on buyback and revenue sharing contract under certain conditions.

Implications of risk-sharing strategies on supply chains with multiple retailers and under random yield

Nowadays, supply chain management cannot be overlooked with the existence of uncertainties caused by both the random demand and the random production yield. This paper considers a supply chain which includes a supplier facing random yield and multiple downstream retailers dealing with random demands. Under a Stackelberg game structure, several analytical models are presented in order to investigate the supply risk sharing mechanism within the supply chains. Under the first scenario, the same contracts (either risk-sharing contract (RS) or no risk-sharing contract (NRS)) are non-discriminatively used for all involving retailers. Then, both RS and NRS contracts are offered to the retailers (namely as a non-identical strategy), which results in the segmentation of the retailer groups. Under both scenarios, the analytical solutions to the retailers' optimal order decisions and the supplier's production decisions are obtained. The random yield impact of the supplier is investigated especially on supply chain performances. The effects of demand uncertainty, production costs' sharing, and wholesale price reduction approaches are explored. The key findings include, first, RS contract may significantly reduce supplier's holding costs; second, RS contract benefit both the supplier and the retailers in comparison with NRS contract; third, by process improvement and technology advancement, if the supplier may reduce the supply random yield effect, supply chain performances can be improved. Numerical examples and managerial insights are presented to illustrate the presented models. The findings may benefit both private companies and government agencies regarding decision making and policy setting in industries with high supply risks such as agriculture and farming related industries.

Does Risk Sharing Contract Foster the Investment Climate of Malaysian Marginal Oil Fields?

The emergence of Risk Sharing Contract (RSC) in the Malaysian oil and gas industry in 2010 was to improve the investment climate for the growing number of marginal oil fields. Notwithstanding the effort, only six RSCs were signed within five years (2010-2014). This warrants for the examination of whether or not the RSC fosters the investment climate of marginal oil fields in Malaysia. For that purpose, a sequential mixed method approach (scenario analysis and interview) was undertaken. The scenario analysis adopts three measures of investment appraisal (Profitability Index, Access to Gross Revenue and Saving Index), to measure investment climate under two scenarios, namely Revenue/Cost factor Profit Sharing Contract (R/C factor PSC) and RSC. The analysis was conducted under different oil price and reserves level. Results reveal that RSC improves the investment climate of marginal oil fields under low and medium oil prices, while R/C factor PSC is better off under higher oil price. The interview provides a consistent result with the scenario analysis. Further, the interview results recommend a few additional incentives in order to foster the marginal oil fields in Malaysia. The findings would provide insights to policymakers in their effort to enhance the attractiveness of marginal oil fields in Malaysia. In the same vein, the study would benefit other countries that experience an increase in the number of marginal oil fields. In line with its findings, the study highlights the scope for improvement. The direction for future research is also highlighted.

Supply chain contract design of procurement and risk-sharing under random yield and asymmetric productivity information

Abstract When procuring from a manufacturer (she) with random yield, the retailer (he) is often reluctant to share the risk caused by this yield, while the manufacturer is not. However, if the manufacturer possesses private productivity information, the retailer may change his decision. To capture the interaction between risk-sharing and asymmetric information, we build a model in which the retailer designs a non-risk-sharing contract (a simple wholesale price contract) or a risk-sharing contract (a wholesale price contract with a subsidy) for the manufacturer given both random yield and private productivity information. The manufacturer’s best response, the optimal contract menus and the supply chain participants’ profits in each case are theoretically derived. By examining the value of risk-sharing, we find that the retailer cannot benefit from risk-sharing under symmetric information. Interestingly, under asymmetric information, risk-sharing benefits not only the manufacturer but also the retailer under certain conditions, resulting in a win-win situation for both the retailer and the manufacturer. Furthermore, we analyze the value of information, illustrating that asymmetric information always harms the retailer and benefits the manufacturer regardless of whether or not the retailer shares risk. However, risk-sharing can weaken (enhance) the effect of asymmetric information on the retailer (manufacturer). Additionally, we derive the optimal contract menus under deterministic yield and find that risk-sharing makes no significance.

Coordination Contracts in a Dual-Channel Supply Chain with a Risk-Averse Retailer

Dual channels have become popular strategies for manufacturers due to the development of innovative selling platforms. Examples in practice also show that the lack of relationship management, such as cooperation and sharing, may cause an unsustainable supply chain performance. However, previous studies on coordination of dual-channel supply chains always focus on the contribution to profits and neglect the sustainability of relationship development between channel members. In this paper, we study the coordination of a dual-channel supply chain including a direct channel and a traditional channel. Under the fact that sustainable economy, instead of profit maximization, is the more appropriate objective in channel members’ decision making, we consider the retailer’s risk exposure and assume the risk degree is also a factor that impacts decision making. We assume the manufacturer is risk-neutral and the retailer is risk-averse, and measure the risk attitude with Conditional Value-at-Risk (CVaR) approach. Two traditional contracts widely used in single-channel supply chains, i.e., revenue-sharing contract and buy-back contract, are analyzed first. Although some researchers have discussed that traditional contracts cannot coordinate the dual-channel supply chain, our results show that traditional contracts can still come into play with restrictions on the risk-averse degree. Then we propose a risk-sharing contract which could distribute profits between two channel members and coordinate the system under varied risk-averse degrees with a fixed risk-sharing degree. Finally, we analyze the sensitivity of different parameters to illustrate the stable coordinating outcomes of this contract, and prove its generalization with more powerful channel members. The results provide important managerial insights.

Project Management under Risk-Sharing Contracts

We study the coordination problem in a setting with multiple contractors working on a project. Specifically, we analyze the risk-sharing contract in which the contractors are paid at the end of the project, after all the tasks have been completed. Although intuitively the contractors should try to complete their tasks early, because under the risk-sharing contract the risk of delay is shared between them and the OEM, we show that the contractors may fail to coordinate their efforts. For a project with parallel tasks, there exist multiple Pareto-ranked equilibria, where all contractors exert the same efforts, and the worst project delay is observed when the contractors play the secure equilibrium. To mitigate this coordination failure, we propose an information feedback policy, and show that the contractors’ efforts in the secure equilibrium increase in the information feedback frequency. Therefore, the OEM may induce the contractors to increase their effort by providing information feedback with frequency that increases linearly in the number of contractors. To test our theoretical findings, we conducted a behavioral experiment that varied the availability of information feedback and the number of contractors. Our experiment confirms that absent feedback, coordination failure occurs, and information feedback is effective in improving the project progress.

Designing coordination contract for biofuel supply chain in China

To ensure the sustainable supply of agricultural feedstock for biofuel production and improve the performance of biofuel supply chain, coordination along the biofuel supply chain in a random yield environment is studied. Three types of coordination contract are examined, namely, an over-production risk-sharing contract (OPC), an under-production risk-sharing contract (UPC), and a mixed contract (MC) with an asymmetric Nash bargaining model. Though an OPC and a UPC can correct the farmers’ over-production and under-production behavior, the expected increase in profit may not be realized by the biofuel producer or the farmers. The MC is feasible because it achieves an efficient supply chain, where supply chain optimization as well as the interests of all individual actors are respected simultaneously. The proposed contracts are tested with data from the cassava-based biofuel industry in China. The findings help practitioners and policy makers understand when and how to implement coordination contracts to achieve the sustainable supply of agricultural feedstock for biofuel production and supply chain Pareto improvement as well.

Pricing strategy and coordination in a dual channel supply chain with a risk-averse retailer

This paper considers a dual channel supply chain consisting of a risk-neutral supplier and a risk-averse retailer, in which the market demand is uncertain and the supplier opens an e-channel, thus directly participating in the market. At the beginning of the sales season, the supplier and the retailer construct their initial stocks, and they follow a consistent pricing strategy. Under the Value-at-Risk (VaR) criterion and the Conditional Value-at-Risk (CVaR) criterion, we formulate the problem as a Stackelberg game model and obtain the equilibrium solutions in the decentralized and centralized situations. Based on the advantage of the CVaR measure, we further explore the effects of the retailer's risk indicator on the retail price, the ordering quantities of the two channels and the profits of the two members, and the total profits of the supply chain. Further, an improved risk-sharing contract is presented to coordinate the dual-channel supply chain and ensures that both supply chain members achieve a win–win outcome. In addition, we make an extension to the case of the inconsistent prices in the two channels, and we also verify that the dual-channel supply chain can be coordinated by the similar improved risk-sharing contract.

Two revenue sharing contracts in a three-echelon supply chain with a risk-neutral or a risk-averse retailer

Purpose: This paper compares the efficiency of two revenue-sharing contracts and discusses the members’ preference for a three-echelon supply chain with the retailer’s different risk attitude. Design/methodology/approach: This paper focuses on a three-echelon supply chain with a manufacturer, a distributor and a retailer. If the retailer is risk-neutral, the coordination of the supply chain based on the two revenue-sharing contracts is comparatively studied. If the retailer is downside-risk-aversion, the supply chain performance is comparatively analyzed and a risk-sharing contract is designed to coordinate the supply chain. Finally, the two revenue-sharing contracts under the risk-sharing contract are still compared. Findings: Although both the two revenue-sharing contracts can coordinate the supply chain with a risk-neutral retailer, they are not always able to coordinate the supply chain with a risk-averse retailer. It is interesting that the supply chain with a risk-averse retailer can be coordinated by executing a designed risk-sharing contract, which is based on any kind of revenue-sharing contract. Finally, any kind of revenue-sharing contracts is not absolutely better than another. Based on the risk-sharing contract, the retailer’s preference is equivalent between the two contracts; but for the distributor and the manufacturer, their preferences between the two contracts are positively related to their own profit share in the supply chain. Originality/value: Comprehensively comparing the two revenue-sharing contracts is the only presented research in the supply chain.

Risk Sharing versus Risk Transfer in Islamic Finance : A Critical Appraisal

Some writers on Islamic finance have recently resuscitated the old ‘no risk, no gain’ precept from the earlier literature in the wake of the 2007-2008 financial crisis. They argue that the basic reason for the recurrence of such crises is the conventional interest-based financial system that subsists purely based on the transfer of risks. In contrast, Islam shuns interest and promotes the sharing of risks, not their transfer. The distinction is used to make a case for replacing the conventional system with the Islamic; for that alone is thought as the way to ensuring the establishment of a just, stableand crisis-free financial system. As evidence to support this thesis, it is cited that Islamic banks have faced the current crisis better than their conventional counterparts. The present paper is a critique of this line of thought. It argues that risk sharing is not basic to Islam. Islam approves profit-and-loss sharing;sharing of risk is a consequence of that, not its cause. There is no such thing as a risk-sharing contract per se in Islamic finance that, when entered into,gives rise to profit-and-loss sharing. The paper concludes that while there is a case for encouraging participatory finance in Islam, there is none for treating risk sharing as its inviolable principle. What really requires emphasis is the need for transparent moral conduct and commitment to Islamic ethical norms.

Modal shift for greener logistics − exploring the role of the contract

Purpose– The purpose of this paper is to investigate contracts of the intermodal transport market and the incentives they create for a modal shift and thus the financial and environmental efficiency of freight transport.Design/methodology/approach– The research used a mixed-methods approach where qualitative case interviews and quantitative modeling was combined. Two cases of contractual relationships between a service provider and its intermodal train operator on a specific lane were investigated. The case findings were then consolidated and used as input for a model of the contractual relation. Findings were sought through an extensive numerical study.Findings– The cases reported that intermodal rail operators had a strong production focus, transferring the capacity risk (i.e. the risk of unused capacity) to the service provider, which the service providers argued limited the shift from truck to intermodal transportation. The paper shows that, due to the market structure, it is rational for the operator to transfer the capacity risk but not the profit. Consequently, a modal shift is only likely to occur when there is strong shipper pressure or low capacity risk. We present a risk-sharing contract that could release this dead lock.Research limitations/implications– The conclusions are modeling outcomes subject to assumptions based on the cases. For further validation, large-scale quantitative studies are necessary.Practical implications– The paper shows that a three-part tariff in which the capacity risk is shared may lead to increased modal shift and hence assumed improved environmental performance.Social implications– Instead of arguing for operators to be more customer-focussed, policy makers and other stakeholders may have more to gain by having both actors being more cooperation focussed.Originality/value– The paper is the first attempt to quantify how the contractual relations on the freight transport market affect the modal mix and thus the financial and environmental efficiency of freight transport.

Optimal fiscal policy in a small open economy with limited commitment

We introduce limited commitment into a standard optimal fiscal policy model in small open economies. We consider the problem of a benevolent government that signs a risk-sharing contract with the rest of the world, and that has to choose optimally distortionary taxes on labor income, domestic debt and international transfers. Both the home country and the rest of the world may have limited commitment, which means that they can leave the contract if they find it convenient. The contract is designed so that, at any point in time, neither party has incentives to exit. We define a small open emerging economy as an economy where the limited commitment problem is active in equilibrium. Conversely, a small open developed economy is an economy in which the commitment problem is not active. Our model is able to rationalize some stylized facts about fiscal policy in emerging economies: i) the volatility of tax revenues over GDP is higher in emerging economies than in developed ones; ii) fiscal policy is procyclical in emerging economies; iii) emerging economies may “graduate” from procyclical fiscal policy and adopt countercyclical policies in the long run.