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The inventory growth spread

By Frederico Belo and Xiaoji Lin

Abstract

Previous studies show that firms with low inventory growth outperform firms with high inventory growth in the cross-section of publicly traded firms. In addition, inventory investment is volatile and procyclical, and inventory-to-sales is persistent and countercyclical. We embed an inventory holding motive into the investment-based asset pricing framework by modeling inventory as a factor of production with convex and nonconvex adjustment costs. The augmented model simultaneously matches the large inventory growth spread in the data, as well as the time-series properties of the firm-level capital investment, inventory investment, and inventory-to-sales. Our conditional single-factor model also implies that traditional unconditional factor models such as the CAPM should fail to explain the inventory growth spread, although not with the same large pricing errors observed in the data

Topics: HG Finance
Publisher: Oxford University Press
Year: 2012
DOI identifier: 10.1093/rfs
OAI identifier: oai:eprints.lse.ac.uk:41377
Provided by: LSE Research Online
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