Brownian Inventory Models with Convex Holding Cost, Part 1: Average-Optimal Controls

By Jim G. Dai, Dacheng Yao. 2013

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We consider an inventory system in which inventory level fluctuates as a Brownian motion in the absence of control. The inventory continuously accumulates cost at a rate that is a general convex function of the inventory level, which can be negative when there is a backlog. At any time, the inventory level can be adjusted by a positive or negative amount, which incurs a fixed cost and a proportional cost. The challenge is to find an adjustment policy that balances the holding cost and adjustment cost to minimize the long-run average cost. When both upward and downward fixed costs are positive, our problem is an impulse control problem. When both fixed costs are zero, our problem is a singular or instantaneous control problem. For the impulse control problem, we prove that a four-parameter control band policy is optimal among all feasible policies. For the singular control problem, we prove that a two-parameter control band policy is optimal. We use a lower-bound approach, widely known as the “verification...

Subfields: Finance, Management Information Systems, Management Science and Operations Research

View Paper: https://www.semanticscholar.org/paper/fc16b17e0ee4117f6c18fc3ca6c8754a878aa04b