Optimal Option Ordering and Pricing Decisions With Capital Constraint and Default Risk

This paper examines a single-period supply chain system consisting of a manufacturer selling an option contract to a capital-constrained retailer who faces stochastic demand. Option contract can transfer partial risk from the retailer to the manufacturer. This paper extends the existing literature of game-theoretic and credit financing models by explicitly incorporating retailer's default risk into the pure option ordering and pricing decision problems. Stackelberg equilibriums under different scenarios, i.e., capital sufficient, capital constraint without credit, bank credit (BC), and trade credit (TC), are derived. The analytic model demonstrates that, under TC, the retailer can behave with and without bankruptcy risk, which depends on the retailer's initial capital. Both the mathematical model and computational experiments reveal that the decisions and profits under BC are independent of retailer's default risk, whereas default risk has a significant impact on the decisions and profits under TC. It shows that TC contract can partially coordinate the supply chain.