To understand whether retailers should consider consumer returns when merchandising, we study how
the optimal assortment of a price-taking retailer is influenced by its return policy. The retailer selects its
assortment from an exogenous set of horizontally differentiated products. Consumers make purchase and
keep/return decisions in nested multinomial logit fashion. Our main finding is that the optimal assortment
has a counterintuitive structure for relatively strict return policies: It is optimal to offer a mix of the most
popular and most eccentric products when the refund amount is sufficiently low, which can be viewed as
a form of risk sharing between the retailer and consumers. In contrast, if the refund is sufficiently high, or
when returns are disallowed, optimal assortment is composed of only the most popular products (a common
finding in the literature). We provide preliminary empirical evidence for one of the key drivers of our results:
more eccentric products have higher probability of return conditional on purchase. In light of our analytical
findings and managerial insights, we conclude that retailers should take their return policies into account
when merchandising