Capacity investment decisions under risk aversion |
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Authors: | Lijian Lu Xiaoming Yan |
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Institution: | 1. Graduate School of Business, Columbia University, New York, New York;2. Goldman Sachs, New York, New York;3. School of Management, University of Science and Technology of China, Heifei, Anhui, People's Republic of China |
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Abstract: | This article studies the optimal capacity investment problem for a risk‐averse decision maker. The capacity can be either purchased or salvaged, whereas both involve a fixed cost and a proportional cost/revenue. We incorporate risk preference and use a consumption model to capture the decision maker's risk sensitivity in a multiperiod capacity investment model. We show that, in each period, capacity and consumption decisions can be separately determined. In addition, we characterize the structure of the optimal capacity strategy. When the parameters are stationary, we present certain conditions under which the optimal capacity strategy could be easily characterized by a static two‐sided (s, S) policy, whereby, the capacity is determined only at the beginning of period one, and held constant during the entire planning horizon. It is purchased up to B when the initial capacity is below b, salvaged down to Σ when it is above σ, and remains constant otherwise. Numerical tests are presented to investigate the impact of demand volatility on the optimal capacity strategy. © 2016 Wiley Periodicals, Inc. Naval Research Logistics 63: 218–235, 2016 |
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Keywords: | capacity expansion risk preference two‐sided (s S) policy (K1 K2)‐concave |
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