The \((S,s)\) policy is an optimal trading strategy in a class of commodity price speculation problems (Q868617)

The authors consider a speculator who can purchase inventories of a durable commodity in a wholesale market at price \(p_{t}\) for a subsequent resale to retail customers at price \(p_{t+j}^{r}\) on business day \(t+j\), \(j\geq 0\). A trading strategy is a rule for purchasing \(q_{t}^{o}\) units of the commodity that depends on the current wholesale market price \(p_{t}\), the level \(q_{t}\) of inventories carried over from yesterday, and a vector \(x_{t}\) of other information. Under the assumption that \(p_{t}^{r}\geq \beta E(p_{t+1}| p_{t},x_{t})\), where \(\beta \in (0,1)\) is the speculator's discount factor, the authors prove that the optimal trading strategy takes the form of an \((S,s)\) policy, which means that the optimal order quantity is given by \(q^{o}(p,q,x)=S(p,x)-q\) if \(q<s(p,x)\) and \(q^{o}(p,q,x)=0\) otherwise, where \(S\) and \(s\) are functions satisfying \(S(p,x)\geq s(p,x)\) for all \(p\) and \(x\). The crucial issue in proving the result is to show that the value function representing the conditional expected present discounted value of following an optimal trading strategy possesses some concavity property in \(q\) for all \((p,x)\). The considered concavity condition is analogous to the notion of \(K\)-convexity introduced by \textit{H. Scarf} [Math. Methods Social Sci., 1959, Proc. 1st Stanford Symp. 196-202 (1960; Zbl 0203.22102)].