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Managing supply chain risk with options and online spot markets

Abstract The objective of this study is to analyze and quantify the benefits of utilizing options and online spot market procurements for hedging demand uncertainty in managing supply chain risk. Retailers can either buy products directly from the supplier, or purchase options on the products, and still there is a spot market to meet in season’s demand for the two parties. The retailer must balance between using options and online spot market procurements to reduce uncertainty and maximizes profit. This study considers the wholesale price to be an equilibrium resulting from a negotiation game between the two parties. Our study shows the interesting finding that options and spot markets are two competing alternatives for hedging demand uncertainty. When the spot market is more attractive, the retailer will deviate to it, thus losing her negotiation power in determining the wholesale price. However, if in the opposite situation, the retailer will use a large amount of options, leading to the information flows, risk sharing, and supply chain efficiency all being improved.