Operational Flexibility and Financial Hedging: Complements or Substitutes

Management Science 2010 INFORMS, Vol. 56, No. 6, June 2010, pp. 1030–1045

16 Pages Posted: 8 Jun 2016

Date Written: June 1, 2010

Abstract

We consider a firm that invests in capacity under demand uncertainty and thus faces two related but distinct types of risk: mismatch between capacity and demand and profit variability. Whereas mismatch risk can be mitigated with greater operational flexibility, profit variability can be reduced through financial hedging. We show that the relationship between these two risk mitigating strategies depends on the type of flexibility: Product flexibility and financial hedging tend to be complements (substitutes) — i.e., product flexibility tends to increase (decrease) the value of financial hedging, and, vice versa, financial hedging tends to increase (decrease) the value of product flexibility — when product demands are positively (negatively) correlated. In contrast to product flexibility, postponement flexibility is a substitute to financial hedging as intuitively expected. Although our analytical results assume perfect flexibility and perfect hedging and rely on a linear approximation of the value of hedging, we validate their robustness in an extensive numerical study.

Keywords: financial hedging; postponement; flexibility; risk management

Suggested Citation

Chod, Jiri and Rudi, Nils and Van Mieghem, Jan Albert, Operational Flexibility and Financial Hedging: Complements or Substitutes (June 1, 2010). Management Science 2010 INFORMS, Vol. 56, No. 6, June 2010, pp. 1030–1045, Available at SSRN: https://ssrn.com/abstract=2790978

Jiri Chod

Boston College ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

Nils Rudi

INSEAD - Technology and Operations Management ( email )

Boulevard de Constance
77 305 Fontainebleau Cedex
France

Jan Albert Van Mieghem (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
54
Abstract Views
852
rank
415,153
PlumX Metrics