Search Costs, Working Capital Management and Asset Pricing

Abstract

How might the cost of searching for information influence asset prices? This paper develops a production-based asset pricing model with imperfect information, in which firms can wait to buy inputs and sell inventories while searching for low cost suppliers and high value customers. Investors, meanwhile, can wait to buy assets while searching for cheap investment opportunities. The model predicts that when search costs rise, profits fall and the marginal utility of consumption spikes, leading investors to discount firms that are especially exposed to search cost risk ex ante. I identify observable firm characteristics related to search costs, and find that some of these variables do predict stock returns. Results suggest that excess inventory can be a hedge against the risk of higher search costs accompanying supply chain fragility or information suppression