Inventory management under uncertainty: A financial theory for the transactions motive

This paper examines the effects of risk aversion and output market uncertainty on optimal inventory policy decisions for a transactions demand for inventory using the capital asset pricing theory. The paper shows that (1) the optimal order quantity of the risk‐adjusted value‐maximizing firm is smaller than that of the expected‐profit‐maximizing one and (2) the greater the firm's output market uncertainty, the smaller its optimal order quantity, where the output market uncertainty is defined as the relative volatility of the demand for the firm's output.