Work

Operating Hedge and Gross Profitability Premium

Year: 2023

Type: article

Abstract: ABSTRACT We show theoretically that variable production costs reduce systematic risk of firms' cash flows if capital and variable inputs are complementary in firms' production and input prices are procyclical. In our dynamic model, this operating hedge effect is weaker for more profitable firms, giving rise to a gross profitability premium. Moreover, gross profitability and value factors are distinct and negatively correlated, and their premia are not captured by the capital asset pricing model (CAPM). We estimate the model by simulated method of moments, and find that its main implications for stock returns and cash flow dynamics are quantitatively consistent with the data.

Source: The Journal of Finance

DOI: 10.1111/jofi.13275

Authors: LEONID KOGAN, JUN LI, HAROLD H. ZHANG

Institutions: University of Cambridge, Massachusetts Institute of Technology, London School of Economics and Political Science, The University of Texas at Dallas, Australian National University, Northeastern University, Peking University, University of Oklahoma, Texas A&M University

Language: English

Topic: Financial Markets and Investment Strategies

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: bronze

OpenAlex ID: W4386699314

FWCI: 4.647

Cites: 37

Cited by: 30

Related to: 10