UCL School of Management

Research seminar

A Structural Estimation of the Bullwhip Effect Using Supply Network Data


Vishal Gaur, Cornell University


Thursday, 11 June 2015
15:00 – 16:30
Torrington Room, Senate House, Malet Street, WC1E 7HU

Inventory fluctuations are often decomposed into cycle stock and safety stock changes. The literature on the bullwhip effect has focused on the former and investigated the contribution of cycle stock changes through demand forecast updating on the occurrence of the bullwhip effect.  In this paper, we argue that the cost ratio (the relationship between holding and penalty costs) that firms use to drive their safety stocks is also time variant, driven by financial and macroeconomic conditions. We develop a two-stage structural model of inventory decisions using financial data for 6,040 unique supplier-customer dyads for the years 1984–2013 for the U.S. economy to investigate downstream inventory adjustments and their influence on upstream firms. Our results show that suppliers overreact to downstream inventory adjustments over and above the demand changes, revealing a new explanation for transient shocks getting amplified upstream in a supply chain. Our structural estimation indicates that inventory cost ratios are dynamic, and that they follow economic and financial sentiment such as liquidity considerations and GDP growth rates. Our counterfactual analysis shows that ~30\% of the estimated bullwhip can be traced to overreaction to inventory changes. For managers, this implies that bullwhip-mitigation strategies must explicitly account for downstream demand forecast updating as well as safety stock changes.

Last updated Monday, 8 June 2015