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Interface of Operations and Finance: A Tutorial

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Innovative Technology at the Interface of Finance and Operations

Part of the book series: Springer Series in Supply Chain Management ((SSSCM,volume 11))

Abstract

We present two tutorials: (1) a finance tutorial for OM researchers and (2) an OM tutorial for finance researchers. We complement textbook treatment of important ideas from one discipline with examples of applications to the other discipline. Our goal is to lower the entry cost for new researchers interested in problems at the interface of the two disciplines.

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Notes

  1. 1.

    This is partial list from an introductory article by Babich and Kouvelis (2018).

  2. 2.

    Suppose that a cash flow x T is paid at time t = T. The operator V alue[⋅] computes the value of this cash flow at t = 0. As we discuss in Sect. 3.3.2, this operator comes from a general asset pricing equation \(Value[x_T] = \mathbb {E}[m_T x_T]\), where m T is a stochastic pricing kernel. Special cases of this asset pricing equation are a risk-neutral valuation (\(Value[x_T] = \mathbb {E}^Q[e^{-r_f T} x_T]\), where \(\mathbb {E}^Q[\cdot ]\) is the expectation with respect to a risk-neutral measure), a CAPM (\(Value[x_T] = \mathbb {E}[e^{-(r_f+\beta (r_M - r_f))T} x_T ]\) where r M is the return on the market and β is the beta of the asset x T relative to the market), a Fama-French 3-factor model, or any other asset pricing model.

  3. 3.

    There are no costs of adjusting leverage in the static tradeoff theory. But the pecking order theory (see discussion in Babich & Birge, 2020) recognizes that trading by insiders of the firm has costs due to signals trading sends to the market.

  4. 4.

    This would be the case if the investment were market-traded. More on this in Sect. 3.3.2.

  5. 5.

    Assumption that is often made in simple finance models.

  6. 6.

    See Sect. 3.4.2 for a discussion of these costs.

  7. 7.

    We use variable v for value because in the newsvendor model variable p represents product sales price.

  8. 8.

    https://operationsroom.wordpress.com/2011/12/09/the-newsvendor-and-the-tax-man-do-americans-not-put-enough-money-into-flexible-spending-accounts/.

  9. 9.

    Function \(f:\mathbb {R}\to \mathbb {R}\) is K-convex for K ≥ 0 if and only if for any x ≤ y, and θ ∈ [0,  1], f(θx + (1 − θ)y) ≤ θf(x) + (1 − θ)(f(y) + K). When K = 0, K-convexity is the regular convexity. For a detailed discussion of K-convexity, see Heyman and Sobel (2004) and Porteus (2002).

  10. 10.

    This game was invented in 1960 by Jay Wright Forrester, who studied system dynamics in his research, and used this game to illustrate the dynamics of supply chains, as well as the importance of information and collaboration (Dizikes, 2015).

  11. 11.

    The demand variability gets magnified akin to the increasing amplitude of the sinusoidal pattern of a bullwhip, as we get further away from the source of the initial variation, hence the name—the bullwhip effect.

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Authors and Affiliations

  1. McDonough School of Business, Georgetown University, Washington, DC, USA

    Volodymyr Babich

  2. University of Chicago Booth School of Business, Chicago, IL, USA

    John Birge

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  1. McDonough School of Business, Georgetown University, Washington, DC, USA

    Volodymyr Babich

  2. University of Chicago Booth, School of Business, Chicago, IL, USA

    John R. Birge

  3. McDonough School of Business, Georgetown University, Washington, DC, USA

    Gilles Hilary

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Babich, V., Birge, J. (2022). Interface of Operations and Finance: A Tutorial. In: Babich, V., Birge, J.R., Hilary, G. (eds) Innovative Technology at the Interface of Finance and Operations. Springer Series in Supply Chain Management, vol 11. Springer, Cham. https://doi.org/10.1007/978-3-030-75729-8_3

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