Modeling newsvendor behavior: A prospect theory approach

• Main Authors: UPPARI, Bhavani Shanker, HASIJA, Sameer
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2019
• Subjects: Newsvendor problem; prospect theory; reference point; pull-to-center effect; model selection; Operations and Supply Chain Management
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/5849; https://ink.library.smu.edu.sg/context/lkcsb_research/article/6848/viewcontent/Modeling_Newsvender_Behavior_av.pdf; https://ink.library.smu.edu.sg/context/lkcsb_research/article/6848/filename/0/type/additional/viewcontent/msom.2017.0701_sm.pdf
• Institution: Singapore Management University

Problem definition: Studies have shown that the behavior of subjects in newsvendor experiments is not consistent with expected profit maximization - an assumption that is often made in operations management literature. Although prospect theory has been established as a popular model of behavioral decision making under uncertainty, it was considered to be inconsistent with observed newsvendor behavior (in particular, the pull-to-center effect) until a recent study proposed a prospect theory model that is consistent with the pull-to-center effect; however, this model's ability in representing newsvendor behavior compared to other plausible prospect theory models is unexplored in the literature. This paper takes a more comprehensive approach in building several prospect theory-based newsvendor models, and evaluates their competence in representing the observed newsvendor behavior. An important feature of these models is that they are not only consistent with the pull-to-center effect, but they can also, in accordance with the findings from recent research, accommodate individual-level heterogeneity in order quantities.