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

35 Pages Posted: 29 May 2019 Last revised: 26 Sep 2019

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. In this paper, we provide evidence that inventory can be used as a financial instrument to take advantage of arbitrage opportunities in financial markets with limited capital mobility. We develop a model based on prevalent industry practices in China to demonstrate how a firm can utilize the inventory of an imported product (typically a commodity) to carry lower-cost capital into a country with strict capital controls, and thus gain higher financial returns. We first use country-level data in China to show that the inventory levels of commodities are positively associated with the expected returns from financial arbitrage. We then utilize firm-level data from China’s metal processing industries (with metal commodities as their primary inputs) to empirically test several model predictions. We find that a higher expected return from financial arbitrage will incentivize a firm to increase its inventory level through increased short-term borrowing. In addition, firms with higher short-term borrowing capacity are more active in using inventory as a financial instrument to seek higher yields.

Keywords: inventory as 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

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