Beyond Risk: Ambiguity in Supply Chains

The distinction between “risk” and “ambiguity” has been long made in influential works in economics and finance by Knight [29], Keynes [27] and Ellsberg [17], among others. Risk refers to the situation where a decision-maker can assign exact probabilities to randomness she faces. Ambiguity, on the other hand refers to the situation where randomness cannot be expressed in terms of exact probabilities. While traditionally risk modeling has dominated the research literature, there has been an increasing interest in ambiguity models. In this article, we review the notion of ambiguity arising from economics and finance and link it to the supply chain context. Our approach is descriptive with a goal to highlight the important aspects of this topic. One of the popular approaches to account for aversion to ambiguity is the maximin expected utility (MEU) theory developed by Gilboa and Schmeidler [20]. We review implications of this theory in a single period newsvendor setting. The newsvendor problem forms the foundation of many operations manage-