Volatility forecasting of market demand as aids for planning manufacturing activities
Abstract
The concepts and techniques designed and used for pricing financial options have been applied to assist in scheduling manufacturing activities. Releasing a manufacturing order is viewed as an investment opportunity whose properties are similar to a call option. Its value can be considered as the derivative of the market demand mirrored in the selling price of the manufactured products and changes over time following an Ito process. Dynamic programming has been used to derive the optimal timing for releasing manufacturing orders. It appears advisable to release a manufacturing when the unit selling price come to a threshold P* given by the relation P* = beta / (beta - 1) C with C = unit cost price. beta is a parameter whose value depends on the trend parameter alpha and the volatility sigma of the selling price, the discount rate rho applicable to the capital appreciation relevant to the business context under consideration. The results have been successfully applied to the evolution of the quarterly construction cost index in France over ten years.