How Does Risk Hedging Impact Operations? Insights from a Price-Setting Newsvendor Model

71 Pages Posted: 5 Jan 2022 Last revised: 13 Jan 2022

See all articles by Liao Wang

Liao Wang

HKU

Jin Yao

HKU Business School, The University of Hong Kong

Xiaowei Zhang

Faculty of Business and Economics, The University of Hong Kong

Date Written: January 4, 2022

Abstract

Financial asset price movement impacts product demand and thus influences operational decisions of a firm. We develop and solve a general model that integrates financial risk hedging into a price-setting newsvendor. The optimal hedging strategy is found analytically, which leads to an explicit objective function for optimization of pricing and service levels. We find that, in general, the presence of hedging reduces the optimal price. It also reduces the optimal service level when the asset price trend positively impacts product demand ("asset price benefits demand''), while it may increase the optimal service level by a small margin when the impact is negative ("asset price hurts demand''). We construct the mean-variance efficient frontier that characterizes the risk-return trade-off, and we quantify the risk reduction achieved by the hedging strategy. Our numerical case study using real data of Ford Motor Company shows that the markdown in price and decrease in service level are small under our model, and the hedging strategy substantially reduces risk without materially reducing operational profit.

Keywords: newsvendor; pricing; risk hedging; mean-variance framework

JEL Classification: C44

Suggested Citation

Wang, Liao and Yao, Erich and Zhang, Xiaowei, How Does Risk Hedging Impact Operations? Insights from a Price-Setting Newsvendor Model (January 4, 2022). Available at SSRN: https://ssrn.com/abstract=4000593 or http://dx.doi.org/10.2139/ssrn.4000593

Liao Wang

HKU ( email )

Meng Wah Complex
Pokfulam Road
Hong Kong
China

Erich Yao (Contact Author)

HKU Business School, The University of Hong Kong ( email )

Hong Kong
China

Xiaowei Zhang

Faculty of Business and Economics, The University of Hong Kong ( email )

Pokfulam Road
Hong Kong
Hong Kong

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