Inventory Investment and the Cost of Capital
50 Pages Posted: 19 Dec 2008 Last revised: 20 Sep 2012
Date Written: February 1, 2012
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 premia, 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.
Keywords: Inventory Investment, Return Predictability
JEL Classification: E32, E44, G31
Suggested Citation: Suggested Citation