Risk Sharing in a Supply Chain

This paper suggests that the profit sharing contract can be Pareto optimal for both supplier and the purchaser. It is shown that Pareto optimal risk sharing contract can be obtained even though the decisions are made in a decentralized manner. The effect of risk attitude of the members of the supply chain is discussed. We examined various aspects of the risk sharing contract such as risk altitude, bargaining power, and cost of information system. The different risk attitude changes the optimal parameters and decision variables. Especially, we proved that, when both the supplier and the purchaser are risk averse, the purchaser orders less quantity than when the one is risk neutral and the other is risk averse. If the fixed cost for the information system is big enough to satisfy a certain condition, it is Pareto optimal not to share the profit and the purchaser takes all the risk even though he is risk averse.

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