A Market-Based Real-Asset Martingale Valuation Approach to Optimum Inventory Control

We propose a novel approach to optimum inventory control by modeling a commodity trader’s inventory investment as a portfolio of forward commitments taking explicit account of the dynamics of demands, costs and prices in open markets. We apply the robust real-asset martingale valuation methodology to derive a closed-form solution for the inventory value and a simple and intuitive optimality condition. Numerical analysis verifies this condition and demonstrates that the resulting optimum policy has robust properties.