Optimal Option Strategy for Manufacturers to Manage Their Product Quality Risks

Abstract

Abstract:

Since the 1990s, supply chain management has brought development opportunities for manufacturers, but at the same time has increased the product quality risks that they confront. In order for manufacturers to reduce the economic losses caused by product quality risks, an option strategy is worked out in the study. It is held in the paper that, by buying the option, a manufacturer can take advantage of the risk absorbing capacities of financial institutions in favor of quality risk management. Primarily, to maximize the mean-variance utility, conditions for manufacturers purchasing the options are analyzed. Furthermore, the optimal option strategies are given for manufacturers to employ in different situations:Scenario-1 describes how manufacturers should decide an optimal strike price when the financial institutions give the dual boundary repair rate of the option; Scenario-2 describes how manufacturers should choose another boundary repair rate when the financial institutions give a strike price and a boundary repair rate. Finally, with the actual repair rate obeying the beta distribution as an example, an analysis of the optimal decision is given to support the option application by manufacturers for product quality risk management.

Key words: product quality risks, mean-variance, option strategies, strike price, repair rate

Chen Jing, Li Pei, Zhang Yongfen. Optimal Option Strategy for Manufacturers to Manage Their Product Quality Risks[J]. , 2017, 29(8): 77-90.

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