Inventory as a Financial Instrument: Evidence from China’s Metal Industries

37 Pages Posted: 29 May 2019 Last revised: 5 May 2022

See all articles by Vernon Hsu

Vernon Hsu

The Chinese University of Hong Kong

Jing Wu

The Chinese University of Hong Kong (CUHK) - CUHK Business School

Date Written: April 1, 2019

Abstract

Classical inventory theory suggests that inventory plays a vital role in matching demand and supply. This paper provides both country-level and firm-level evidence that inventory can be used as a financial instrument to take advantage of arbitrage opportunities in financial markets with limited capital mobility. Using data from China customs’ metal imports and firm-level inventory from metal processing industries, we show that firms can utilize the inventory of an imported product to carry lower-cost capital into a country with strict capital controls and thus gain higher financial returns. Specifically, at the country level, we find that the level of imported metal commodities is positively associated with the expected returns from financial arbitrage. At the firm level, we find that a higher expected return from financial arbitrage will incentivize a firm to increase its inventory level through short-term borrowing. In addition, firms with higher liquidation value, larger size, and higher sales growth (i.e., firms with higher borrowing capacity) are more active in using inventory as an instrument to seek higher financial gains. We also utilize a unique regulatory policy shock as a quasi-natural experiment to enhance the causality interpretation of our empirical findings.

Keywords: inventory, financial instrument, operations-finance interface, empirical research

Suggested Citation

Hsu, Vernon and Wu, Jing, Inventory as a Financial Instrument: Evidence from China’s Metal Industries (April 1, 2019). Available at SSRN: https://ssrn.com/abstract=3382807 or http://dx.doi.org/10.2139/ssrn.3382807

Vernon Hsu

The Chinese University of Hong Kong ( email )

Room 902
Cheng Yu Tung Building, No. 12 Chak Cheung Street
Hong Kong, 00000
China

Jing Wu (Contact Author)

The Chinese University of Hong Kong (CUHK) - CUHK Business School ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Shatin, N.T.
Hong Kong

HOME PAGE: http://www.jingwulab.org

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