Risk Hedging for Production Planning

Abstract

Traditional production planning is primarily a quantity or capacity decision, which must be made at the beginning of a planning horizon before production starts. Adding to this decision a real-time control, a risk-hedging strategy carried out throughout the horizon can better mitigate the risk involved in demand volatility. We demonstrate how this can be done in terms of jointly optimizing the capacity and the hedging decisions, addressing both the mean-variance and the shortfall objectives. Solution techniques, results, and insights are highlighted. In particular, we illustrate that our approach readily accommodates data analytics and explicitly quantifies the improvement to the efficient frontier contributed by hedging.