Output Decision Under Demand Uncertainty with Stochastic Production Function: A Contingent Claims Approach

Management Science, Vol. 36, No. 11, pp. 1311-1328, November 1990

Posted: 15 Dec 2009

See all articles by Kee H. Chung

Kee H. Chung

State University of New York at Buffalo - School of Management

Date Written: November 1990

Abstract

This paper presents a contingent claims analysis of output decisions for the firm facing technological and demand uncertainty. The paper reveals that: (i) the optimal output level increases with the higher interest rate when the firm is subject to demand (and technological) uncertainty; (ii) the effect of demand volatility and production lead time on the optimal output level could be either positive or negative; (iii) the optimal project value decreases with the higher demand volatility; (iv) the optimal project value decreases with the longer production lead time when the firm is subject to demand uncertainty; and (v) the optimal project value decreases with the higher interest rate when the firm is subject to demand uncertainty; it increases with the higher interest rate, however, when the firm is subject to both demand and technological uncertainty. Some important managerial implications are discussed.

Suggested Citation

Chung, Kee H., Output Decision Under Demand Uncertainty with Stochastic Production Function: A Contingent Claims Approach (November 1990). Management Science, Vol. 36, No. 11, pp. 1311-1328, November 1990, Available at SSRN: https://ssrn.com/abstract=1521567

Kee H. Chung (Contact Author)

State University of New York at Buffalo - School of Management ( email )

Buffalo, NY 14260
United States
716-645-3262 (Phone)
716-645-3823 (Fax)

HOME PAGE: http://mgt.buffalo.edu/faculty/academic-departments/finance/faculty/kee-chung.html

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