Inventory Investment and the Cost of Capital

50 Pages Posted: 19 Dec 2008 Last revised: 20 Sep 2012

See all articles by Christopher S. Jones

Christopher S. Jones

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Selale Tuzel

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Date Written: February 1, 2012

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 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

Jones, Christopher S. and Tuzel, Selale, Inventory Investment and the Cost of Capital (February 1, 2012). Available at SSRN: https://ssrn.com/abstract=1317457 or http://dx.doi.org/10.2139/ssrn.1317457

Christopher S. Jones

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

Selale Tuzel (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

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