The Puzzling Inventory Growth Risk Premium

Abstract

In the cross-section of U.S. publicly traded firms, we document that the spread in expected returns between firms with high versus low inventory growth rates is as high as 7% per annum, after controlling for differences across the firm's capital investment rate. We investigate the ability of existing macroeconomic models of inventory behavior to simultanesously match the cross-sectional properties of asset prices and real quantities in the data. Calibrated to match quantities as close to the data as possible, we find that none of the models considered here can quantitatively explain the observed large dispersion in tisk associated with inventory growth. Adding convex adjustment costs in inventory investment slightly improves the ability of those models to match the asset pricing facts, but it deterioirates the fit along the quantity dimension. We conclude that the strong link between inventory growth and firms' rosk documented here is a quantitative puzzle for existing macroeconomic models of inventory behavior.