Financial valuation of flexible supply chain contracts

Abstract

We consider a single buyer - single supplier multiple period quantity flexibility contract in which the buyer has options to buy in case of a higher than expected demand in addition to the committed purchases at the beginning of each period of the contract. We take the buyer’s point of view and find the maximum value of the contract for the buyer by analyzing the financial and real markets simultaneously. We assume both markets evolve as discrete scenario trees. Furthermore, under the assumption that the demand of the item correlates perfectly with the price of the risky security we present a model to find the buyer’s maximum acceptable price of the contract. Applying duality, we develop sufficient conditions on some parameters to decrease the value of the contract. Then, an experimental study is presented to illustrate the impacts of all the parameters on the value of the contract and the option. We show that the model can also be extended to the case of partially correlated demand and the risky asset price under the assumption that the markets evolve as binomial trees. Finally, we apply duality and perform numerical analysis for the latter assumption.