On the heavy-tail behavior of the distributionally robust newsvendor

TL;DR

This paper extends the distributionally robust newsvendor model to account for heavy-tailed demand distributions, showing that the optimal order quantity remains effective for distributions with power-law tails, especially under contamination.

Contribution

It generalizes the heavy-tail optimality property of the robust newsvendor to moments of any order greater than one, broadening its applicability.

Findings

Optimal order quantity is also optimal for regularly varying heavy-tailed distributions.

The model outperforms traditional distributions under contamination in high service level regimes.

Numerical experiments demonstrate robustness against heavy-tailed demand contamination.

Abstract

Since the seminal work of Scarf (1958) [A min-max solution of an inventory problem, Studies in the Mathematical Theory of Inventory and Production, pages 201-209] on the newsvendor problem with ambiguity in the demand distribution, there has been a growing interest in the study of the distributionally robust newsvendor problem. The model is criticized at times for being overly conservative since the worst-case distribution is discrete with a few support points. However, it is the order quantity prescribed from the model that is of practical relevance. A simple calculation shows that the optimal order quantity in Scarf's model with known first and second moment is also optimal for a censored student-t distribution with parameter 2. In this paper, we generalize this "heavy-tail optimality" property of the distributionally robust newsvendor to an ambiguity set where information on the first and the $\alpha$th moment is known, for any real number $\alpha > 1$. We show that the optimal order quantity for the distributionally robust newsvendor problem is also optimal for a regularly varying distribution with roughly a power law tail with tail index $\alpha$. We illustrate the usefulness of the model in the high service level regime with numerical experiments, by showing that when a standard distribution such as the exponential or lognormal distribution is contaminated with a heavy-tailed (regularly varying) distribution, the distributionally robust optimal order quantity outperforms the optimal order quantity of the original distribution, even with a small amount of contamination.