Document Type

Article

Publication Date

9-2014

Publication Source

Production and Operations Management

Abstract

The authors of this paper outline a capacity planning problem in which a risk-averse firm reserves capacities with potential suppliers that are located in multiple low-cost countries. While demand is uncertain, the firm also faces multi-country foreign currency exposures. This study develops a mean-variance model that maximizes the firm’s optimal utility and derives optimal utility and optimal decisions in capacity and financial hedging size. The authors show that when demand and exchange rate risks are perfectly correlated, a risk- averse firm, by using financial hedging, will achieve the same optimal utility as a risk-neutral firm. In this paper as well, a special case is examined regarding two suppliers in China and Vietnam. The results show that if a single supplier is contracted, financial hedging most benefits the highly risk-averse firm when the demand and exchange rate are highly negatively related. When only one hedge is used, financial hedging dominates operational hedging only when the firm is very risk averse and the correlation between the two exchange rates have become positive. With both theoretical and numerical results, this paper concludes that the two hedges are strategic tools and interact each other to maximize the optimal utility.

Inclusive pages

1495–1510

ISBN/ISSN

1059-1478

Document Version

Postprint

Comments

First published online Jan. 10, 2014. The document available for download (after an 18-month embargo from the date of first publication) is the authors' accepted manuscript. Some differences may exist between this version and the published version; as such, researchers wishing to quote directly from this resource are advised to consult the version of record.

Permission documentation is on file.

Publisher

John Wiley & Sons, Inc.

Volume

23

Issue

9

Place of Publication

Hoboken, NJ

Peer Reviewed

yes