Inventory investment and the cost of capital |
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| Authors: | Christopher S Jones Selale Tuzel |
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| Institution: | 1. Federal Reserve Board, Division of Research and Statistics, Capital Markets MS-89, 20th & C street, Washington, DC 20551, United States;2. Naveen Jindal School of Management, University of Texas at Dallas, SM31, P.O.Box 830699, Richardson, TX 75083-0699, United States;1. Lerner College of Business & Economics, University of Delaware, Newark, DE 19716, USA;2. College of Business Administration, University of Tennessee, Knoxville, TN 37996, USA;1. Asso. Prof. & Head of Mechanical Engg. Deaprtment, S.C.O.E.M, Limb., Satara, Maharashtra, India;2. Professor & Head of Production Engg Department, College of Engg, Pune, Maharashtra, India;1. Columbia Business School, Uris Hall 805, Broadway 3022, NYC, NY 10027, United States;2. Columbia Business School, Uris Hall 810, Broadway 3022, NYC, NY 10027, United States;3. Haas School of Business, University of California, Berkeley, 545 Student Services Building #1900, Berkeley, CA 94720-1900, United States;1. Desautels Faculty of Management, McGill University, 1001 Sherbrooke Street West, Montreal, QC H3A 1G5, Canada;2. College of Business and Innovation, University of Toledo, 2801 West Bancroft St, Toledo, OH 43606, United States;1. Saïd Business School, Oxford-Man Institute of Quantitative Finance, Park End Street, Oxford OX1 1HP, UK;2. CEPR, UK |
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| Abstract: | We examine the relation between inventory investment and the cost of capital in the time series and the cross section. We find consistent evidence that risk premiums, rather than real interest rates, are strongly negatively related to future inventory growth at the aggregate, industry, and firm levels. The effect is stronger for firms in industries that produce durables rather than nondurables, exhibit greater cyclicality in sales, require longer lead times, and are subject to more technological innovation. We then construct a production-based asset pricing model with two types of capital, fixed capital and inventories, to explain these empirical findings. Convex adjustment costs and a countercyclical price of risk lead to negative time series and cross-sectional relations between expected returns and inventory growth. |
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