Optimal option purchase decision of a loss-averse retailer under emergent replenishment

Xinsheng Xu, Felix T.S. Chan, Chi Kin Chan

Research output: Journal article publicationJournal articleAcademic researchpeer-review

15 Citations (Scopus)

Abstract

This paper studies the optimal option purchase of a loss-averse retailer under emergent replenishment. It is assumed that all or part of the excess demands in a stock-out situation can be replenished, and the loss-averse retailer's optimal option purchase quantity is investigated. It is found that the loss-averse retailer should not purchase options and only needs to replenish the inventory under certain conditions. When maximizing the expected utility without shortage cost, the loss-averse retailer's optimal option purchase quantity is decreasing in the loss aversion coefficient. To maximise the expected utility with shortage cost, a larger shortage cost implies a bigger option purchase quantity. If the shortage cost exists, there will be a loss on the expected profit and utility for the loss-averse retailer who selects an optimal option purchase quantity without shortage cost. Given the optimal option purchase quantity, it is proven that the loss-averse retailer's expected profit is decreasing in the loss aversion coefficient. Therefore the retailer should choose a proper loss aversion preference to balance between the two objectives of profit maximization and loss aversion preference. As a result of these findings, some management insights are recommended to the loss-averse retailer in selecting the option purchase quantity.

Original languageEnglish
Pages (from-to)4594-4620
Number of pages27
JournalInternational Journal of Production Research
Volume57
Issue number14
DOIs
Publication statusPublished - 18 Jul 2019

Keywords

  • loss-averse
  • option contract
  • purchasing
  • replenishment
  • shortage cost

ASJC Scopus subject areas

  • Strategy and Management
  • Management Science and Operations Research
  • Industrial and Manufacturing Engineering

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