Integrated Operational and Financial Hedging Across Multiple Markets: A Value-at-Risk Approach

52 Pages Posted: 17 Feb 2023

See all articles by Jian Chen

Jian Chen

Tsinghua University - School of Economics and Management

Qing Ding

School of Management, Huazhong University of Science and Technology

Long Ren

University of International Business and Economics (UIBE)

Jing-Sheng Jeannette Song

Duke University - Fuqua School of Business

Date Written: February 15, 2023

Abstract

We study the optimal integrated capacity and financial hedging strategies for a downside risk-averse global firm that faces multiple demand and foreign exchange rate risks. The firm seeks to maximize its expected profit while controlling its profit risk through a Value-at-Risk (VaR) constraint, which ensures the probability of profit falling below a reservation level is within tolerance. We introduce a tractable approach to resolving the well-known challenging VaR constraint, enabling analysis of multiple foreign markets -- a significant advancement over the usual single foreign market focus in the literature under other risk measures. We characterize efficient financial hedging under any given capacity in a general form with continuous strike price and general stochastic distribution that can be replicated with vanilla derivatives, making the profit reservation level and tolerance level interchangeable. Our findings reveal that the optimal capacity choice is either the risk-neutral solution or on the boundary of the feasible region, differing from the mean-variance framework where multiple solutions may occur for multi-markets. Furthermore, we demonstrate that while operational hedging boosts expected profits directly, financial hedging lowers the chance of incurring risks. These strategies can substitute or complement each other in managing downside risks, serving distinct purposes in risk control.

Keywords: capacity investment, financial hedging, value-at-risk, integrated risk management, global supply chain

Suggested Citation

Chen, Jian and Ding, Qing and Ren, Long and Song, Jing-Sheng Jeannette,
Integrated Operational and Financial Hedging Across Multiple Markets: A Value-at-Risk Approach
(February 15, 2023). Available at SSRN: https://ssrn.com/abstract=4359370 or http://dx.doi.org/10.2139/ssrn.4359370

Jian Chen

Tsinghua University - School of Economics and Management ( email )

Beijing, 100084
China

Qing Ding

School of Management, Huazhong University of Science and Technology ( email )

1037 Luoyu Road
Wuhan, Hubei 430074
China

Long Ren (Contact Author)

University of International Business and Economics (UIBE) ( email )

No. 10, Huixin dongjie, Chaoyang district
Beijing
China

Jing-Sheng Jeannette Song

Duke University - Fuqua School of Business ( email )

100 Fuqua Drive
Duke University
Durham, NC 27708
United States

HOME PAGE: http://people.duke.edu/~jssong/

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