Transfer of risk in the newsvendor model with discrete demand

This is a pre-copyedited, author-produced PDF of an article accepted for publication in Omega : The International Journal of Management Science, following peer review. The final publication Omega : The International Journal of Management Science 2012, 40(3):404-414 is available at Elsevier via DOI: 10.1016/j.omega.2011.07.001 .In this paper we consider the transfer of risk in a newsvendor model with discrete demand. We view the newsvendor model as a leader/follower problem where the manufacturer (leader) decides the wholesale price and the retailer (follower) decides the quantity ordered. Taking a Pareto-optimal contract as a starting point, the manufacturer wishes to design a real option contract to enhance profits. A new real option contract is said to be feasible if both parties' expected profit is at least as great as in the original contract. When demand is discrete, there are usually infinite feasible contracts that yield maximum expected profits to the manufacturer. In the paper we show that either all, some or none of these real option contracts offer an improved position for the retailer