Risk pooling under demand and price uncertainty

Abstract

This paper studies purchasing a commodity or a perishable item under stochastically evolving and correlated prices for a distribution system environment. We consider the central purchasing of the commodity under the demand process correlated with the random price and decide on the timing and quantity of allocation to demand locations. As an implementation of the physical pooling concept, we investigate the benefits of pooling price and demand risk when the forward purchase is realized for all demand locations. We also study the benefits of informational pooling concepts by deciding on the allocation timing. Even when the demand locations are independent entities, organizing joint purchasing of a commodity may take advantage of economies of scale with a more reliable and less expensive delivery option. We develop a model to guide the purchasing and allocation of quantities and employ multi-echelon inventory theory methods and stochastic processes commonly used in financial engineering and operations management literature.