On Credit Risk in Supply Chains: Is Negative Default Correlation Among Suppliers Desirable?

We study the effects of credit risk in a supply chain where one retailer deals with competing risky suppliers who may default during their production lead-times. The suppliers, who compete for business with the retailer by establishing wholesale prices, are leaders in a Stackelberg game with the retailer. The retailer, facing uncertain future demand, chooses order quantities while weighing the benefits of procuring from the cheapest supplier against the advantages of reducing credit risk through diversification. If the wholesale prices were exogenous, the retailer would benefit from decreasing correlation of defaults. However, when prices are endogenous, decreasing the correlation dampens competition among the suppliers, increasing the equilibrium wholesale prices. We show that the retailer prefers suppliers with positively correlated default events. In contrast, the suppliers and the channel prefer defaults that are negatively correlated.