Brown Bag Seminar - Alexandre Corhay (Rotman), Inventories, Macroeconomic Risk, and the Cross-Section of Stock Returns

Abstract: We study how firms’ inventory policies shape their exposure to aggregate demand and supply shocks. In a production-based asset pricing model with inventory management, we show that the shadow value of inventories reflects two opposing forces: a cost-smoothing channel that hedges adverse supply shocks by allowing firms to sell from inventory when marginal costs rise, and a stock-out option value that amplifies exposure to demand shocks as inventories become less valuable in low-demand states. This duality implies that inventories can act as either a hedge or a source of risk, depending on the shock. Empirically, firms with higher inventories load positively on demand shocks and negatively on supply shocks, and the resulting inventory premium varies with the prices of these risks. Inventories thus play a central role in transmitting fundamental macroeconomic shocks into asset prices.