Supply portfolio risk

In a single period framework, we develop a supply portfolio risk assessment tool for raw material procurement in the presence of supply risk (due to contract breaches), demand risk and the spot price risk. Contract breaches are operational risk events that are classified under "Clients, Products and Business Practices" category of Basel II framework. We allow for the negative financial impact of intentional long term fixed price contract breaches to be mitigated by using the spot market. The manufacturer uses the spot market to procure her need in the presence of a contract breach as well as to handle the shortfall/excess in customer demand. We use the CreditRisk+ framework well known in finance literature to extend the single supplier model to a portfolio of suppliers. This extension enables us to obtain, in the context of supply risk, the entire loss distribution at the portfolio level. In particular, akin to the Value-at-Risk statistic in finance, one can easily obtain a simple yet effective quantile measure of supply risk, coined as Supply-at-Risk (SaR), for a portfolio of long term fixed price supply contracts.