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Operating Hedge and Gross Profitability Premium

Author

Listed:
  • Leonid Kogan
  • Jun Li
  • Harold Zhang

Abstract

We show theoretically that variable production costs lower systematic risk of firms’ cash flows if capital and variable inputs are complementary in firms’ production and input prices are pro-cyclical. 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 CAPM. We estimate the model by the simulated method of moments, and find that its main implications for stock returns and cash flow dynamics are quantitatively consistent with the data.

Suggested Citation

  • Leonid Kogan & Jun Li & Harold Zhang, 2022. "Operating Hedge and Gross Profitability Premium," NBER Working Papers 30241, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:30241
    Note: AP
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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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