Integrating commodity markets in the procurement policies for different supply chain structures

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Goel, Ankur, 1976-

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This research develops a mathematical model of procurement for commodities which integrates the arbitrage free pricing models for commodities in Finance with the traditional inventory models of Operations Management. In essence, we develop a model that uses market determined information on spot and futures prices to ascertain the optimal procurement strategy. This research is an attempt to understand how firms should adapt their operating policies in presence of fluctuating commodity prices. In this research we seek to understand how the term structure of futures prices at a commodity market can be used in the formulation of procurement and distribution policies of supply chains under centralized decision making. The difference between spot and futures prices play an important role in the determination of the actual cost of holding a commodity; the cost of holding a unit of a tradable commodity is a random variable whose values are determined by the stochastic evolution of prices at the commodity market, and it is exogenously imposed on the firm. The benefits derived from storing a unit of the commodity, on the other hand, are endogenous to each firm and depends on its operational characteristics. Our research objective is to understand how the internal operational decisions of the firm should be modified as a function of the spot and futures prices observed in the market, in order to achieve an optimal balance between cost and benefits of holding an inventory. We model prices with a stochastic process that allows no risk-free arbitrage opportunities, and in this setting, we characterize optimal procurement and distribution policies for various supply chain structures. In addition, we explore the value of using two factor price model over one-factor price model on procurement costs. Our results suggest that there are substantial cost savings in inventory related costs on incorporating spot and futures price information in the procurement model. Furthermore, two-factor model yields higher cost savings than using a single factor model to forecast prices. Distribution of commodities requires the understanding of price dynamics on the commodity markets as well as the issues related to supply chains. This dissertation is an attempt to contribute to the understanding of this area of research.