“A Theory of Contingent Claim Design and Application to Integrated Financial-Operational Risk Management in the Newsvendor Model” by Professor Andrea Roncoroni
Professor Andrea Roncoroni
Professor of Finance
Department of Finance
ESSEC Business School
A large body of asset pricing literature is devoted to the direct problem of derivative pricing: given a payoff schedule, one looks for a rational theory to assign a corresponding fair value. A comparatively smaller attention has been paid to the inverse problem of derivative origination, whereby an economic agent seeks an affordable claim to optimize a standing business position. Yet, claim design is of great relevance in the value chain of financial business operations, nested inside the functional area of product design. We seek to remedy this oversight by: (i) providing a comprehensive theory for the optimal design of combined custom financial claims to hedge corporate exposure mixing financially insurable and noninsurable risk terms; (ii) quantitatively assessing the firm’s utility gain over the best existing alternatives available so far, and (iii) analyzing the value enhancement of integrating the optimal combined custom hedge into optimal operations management, in keeping with a holistic approach to risk management as advocated in Birge (2015) (“OM Forum-Operations and Finance Interactions.” Manufacturing & Service Operations Management 17(1), 4-15). All aspects of our methodology are illustrated within the Newsvendor Model.