Two essays on the interface of finance, operations, and risk management

Abstract

In practice, the intersection of finance, operations, and risk management presents complex challenges for firms as they strive to enhance profit while managing risk. This thesis, which consists of two essays, aims to understand the interactions among them and explore solutions to help firms to better make operational and financial decisions while managing the associated risks.

In the first essay, we focus on risk management in supply chains. Specifically, we examine how risk hedging affects operational decisions. It is well documented that if a financial asset's price movement impacts a firm's product demand, the firm can respond to the impact by adjusting its operational decisions. For example, in the automotive industry, car makers decrease the selling prices of fuel-inefficient cars when the oil price rises. Meanwhile, the firm can implement a risk-hedging strategy using the financial asset jointly with its operational decisions. Motivated by this, we develop and solve a general risk-management model integrating risk hedging into a price-setting newsvendor. The optimal hedging strategy is calculated analytically, which leads to an explicit objective function for optimizing price and ``virtual production quantity'' (VPQ). (The latter determines the service level, i.e., the demand fulfillment probability.) We find that hedging generally reduces the optimal price {when the firm sets the target mean return as its production-only maximum expected profit. With the same condition on the target mean return}, hedging also reduces the optimal VPQ when the asset price trend positively impacts product demand; meanwhile, it may increase the VPQ by a small margin when the impact is negative. We construct the return-risk efficient frontier that characterizes the optimal return-risk trade-off. Our numerical study using data from a prominent automotive manufacturer shows that the markdowns in price and reduction in VPQ are small under our model and that the hedging strategy substantially reduces risk without materially reducing operational profit.

In the second essay, we examine how trade credit affects supply chain interactions and efficiency. It is well-documented, yet puzzling, that trade credit is widely used among firms that have easy access to alternative financing channels (e.g., bank credit). In this essay, we propose a novel explanation to this phenomenon. We consider a two-period bilateral supply chain model where the buyer makes demand boosting capacity investments. The two party negotiate the supply contract via an alternative-offer bargaining model. We find that under this bargaining framework, trade credit re-balances the bargaining power in the supply chain, altering how the total payoff is shared between the two parties. This in turn alleviates the holdup problem that hinders capacity investment without trade credit. As such, both the level of capacity investment and the profits of two supply chain parties are higher under trade credit than those under cash on delivery. Specifically, we find that in the second period, trade credit can eliminate the holdup problem, and the benefit from trade credit does not depend on the trade credit recovery rate, the trade credit collection rate and the market shrinkage rate. In the first period, the equilibrium trade credit amount increases with the trade credit collection rate and market shrinkage rate, and decreases with recovery rate and cash discount rate.