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An Empirical Model of Inventory Investment by Durable Commodity Intermediaries

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  • George Hall

    (Yale University)

  • John Rust

    (Yale University)

Abstract

We present a new detailed data set of high-frequency observations on inventory investment by a U.S. steel wholesaler. Our analysis of the data leads to six main conclusions: orders and sales are made infrequently; orders are more volatile than sales; order sizes vary considerably; there is considerable day-to-day variability in sales prices; inventory/sales ratios are unstable; and there are occasional stockouts. We model the firm generically as a durable commodity intermediary. We demonstrate that the firm's behavior at the product level is well approximated by an optimal trading strategy derived from a multi-dimensional nonlinear dynamic programming problem with continuous state and control variables which are subject to frequently binding inequality constraints. We show that the optimal trading strategy takes the form of a generalized (S,s) rule in which the (S,s) bands are decreasing functions of the spot price. We simulate a calibrated version of this model, and show that the simulated data exhibit the key features of inventory investment we observe in our data.

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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 9904005.

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Length: 40 pages
Date of creation: 12 Apr 1999
Date of revision:
Handle: RePEc:wpa:wuwpma:9904005

Note: TeX file, Postscript version submitted, 40 pages
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References

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  1. George J. Hall, 1997. "Non-Convex Costs and Capital Utilization: A Study of Production Scheduling at Automobile Assembly Plants," Cowles Foundation Discussion Papers 1169, Cowles Foundation for Research in Economics, Yale University.
  2. Andrew B. Abel, 1985. "Inventories, Stock-Outs, and Production Smoothing," NBER Working Papers 1563, National Bureau of Economic Research, Inc.
  3. Deaton, Angus & Laroque, Guy, 1992. "On the Behaviour of Commodity Prices," Review of Economic Studies, Wiley Blackwell, vol. 59(1), pages 1-23, January.
  4. Fisher, Jonas D M & Hornstein, Andreas, 2000. "(S, s) Inventory Policies in General Equilibrium," Review of Economic Studies, Wiley Blackwell, vol. 67(1), pages 117-45, January.
  5. James A. Kahn & Mark Bils, 2000. "What Inventory Behavior Tells Us about Business Cycles," American Economic Review, American Economic Association, vol. 90(3), pages 458-481, June.
  6. Olivier J. Blanchard, 1982. "The Production and Inventory Behavior of the American Automobile Industry," NBER Working Papers 0891, National Bureau of Economic Research, Inc.
  7. Alan S. Blinder, 1986. "More on the Speed of Adjustment in Inventory Models," NBER Working Papers 1913, National Bureau of Economic Research, Inc.
  8. Williams,Jeffrey C. & Wright,Brian D., 2005. "Storage and Commodity Markets," Cambridge Books, Cambridge University Press, number 9780521023399, April.
  9. Miron, Jeffrey A & Zeldes, Stephen P, 1988. "Seasonality, Cost Shocks, and the Production Smoothing Models of Inventories," Econometrica, Econometric Society, vol. 56(4), pages 877-908, July.
  10. Timothy F. Bresnahan & Valerie A. Ramey, 1992. "Output Fluctuations at the Plant Level," NBER Working Papers 4105, National Bureau of Economic Research, Inc.
  11. Jeffrey A. Miron & Stephen P. Zeldes, 1988. "Production, Sales, and the Change in Inventories: An Identity That Doesn`t Add Up," NBER Working Papers 2765, National Bureau of Economic Research, Inc.
  12. John Rust & Department of Economics & University of Wisconsin, 1994. "Using Randomization to Break the Curse of Dimensionality," Computational Economics 9403001, EconWPA, revised 04 Jul 1994.
  13. Caplin, Andrew S, 1985. "The Variability of Aggregate Demand with (S, s) Inventory Policies," Econometrica, Econometric Society, vol. 53(6), pages 1395-1409, November.
  14. Ramey, Valerie A. & West, Kenneth D., 1999. "Inventories," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 13, pages 863-923 Elsevier.
  15. Eichenbaum, Martin, 1989. "Some Empirical Evidence on the Production Level and Production Cost Smoothing Models of Inventory Investment," American Economic Review, American Economic Association, vol. 79(4), pages 853-64, September.
  16. Fair, Ray C., 1989. "The production-smoothing model is alive and well," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 353-370, November.
  17. Kenneth D. West, 1985. "A Variance Bounds Test of the Linear Quardractic Inventory Model," NBER Working Papers 1581, National Bureau of Economic Research, Inc.
  18. Alan S. Blinder, 1984. "Can The Production Smoothing Model of Inventory Behavior be Saved?," NBER Working Papers 1257, National Bureau of Economic Research, Inc.
  19. Kahn, James A, 1992. "Why Is Production More Volatile Than Sales? Theory and Evidence on the Stockout-Avoidance Motive for Inventory-Holding," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 481-510, May.
  20. Ramey, Valerie A, 1991. "Nonconvex Costs and the Behavior of Inventories," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 306-34, April.
  21. Martin Feldstein & Alan Auerbach, 1976. "Inventory Behavior in Durable-Goods Manufacturing: The Target-Adjustment Model," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 7(2), pages 351-408.
  22. Eichenbaum, Martin S., 1984. "Rational expectations and the smoothing properties of inventories of finished goods," Journal of Monetary Economics, Elsevier, vol. 14(1), pages 71-96, July.
  23. John Rust, 1997. "A Comparison of Policy Iteration Methods for Solving Continuous-State, Infinite-Horizon Markovian Decision Problems Using Random, Quasi-random, and Deterministic Discretizations," Computational Economics 9704001, EconWPA.
  24. John Rust & Joseph Traub & Henryk Wozniakowski, 1999. "No Curse of Dimensionality for Contraction Fixed Points Even in the Worst Case," Computational Economics 9902001, EconWPA.
  25. Kahn, James A, 1987. "Inventories and the Volatility of Production," American Economic Review, American Economic Association, vol. 77(4), pages 667-79, September.
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Citations

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Cited by:
  1. George Alessandria & Joseph Kaboski & Virgiliu Midrigan, 2008. "Inventories, lumpy trade, and large devaluations," Working Paper Series 2008-24, Federal Reserve Bank of San Francisco.
  2. Florian Zettelmeyer & Fiona Scott Morton & Jorge Silva-Risso, 2006. "Scarcity Rents in Car Retailing: Evidence from Inventory Fluctuations at Dealerships," NBER Working Papers 12177, National Bureau of Economic Research, Inc.
  3. Joao Miguel Ejarque, 2008. "Evaluating the Economic Cost of Strategic Storage of Natural Gas," Economics Discussion Papers 658, University of Essex, Department of Economics.
  4. Aubhik Khan & Julia K. Thomas, 2002. "Inventories and the business cycle: an equilibrium analysis of (S,s) policies," Working Papers 02-20, Federal Reserve Bank of Philadelphia.
  5. Oleksiy Kryvtsov & Virgiliu Midrigan, 2009. "Inventories, Markups, and Real Rigidities in Menu Cost Models," Working Papers 09-6, Bank of Canada.
  6. George Hall and John Rust, Yale University, 2001. "Econometric Methods for Endogenously Sampled Time Series: The Case of Commodity Price Speculation in the Steel Market," Computing in Economics and Finance 2001 274, Society for Computational Economics.
  7. Ejarque, João Miguel, 2011. "Evaluating the economic cost of natural gas strategic storage restrictions," Energy Economics, Elsevier, vol. 33(1), pages 44-55, January.
  8. John Rust & George Hall, 2002. "Middlemen versus Market Makers: A Theory of Competitive Exchange," NBER Working Papers 8883, National Bureau of Economic Research, Inc.
  9. Blume, Lawrence E. & Easley, David & Kleinberg, Jon & Tardos, Éva, 2009. "Trading networks with price-setting agents," Games and Economic Behavior, Elsevier, vol. 67(1), pages 36-50, September.
  10. Jia Yan & John Liu, 2008. "Instability of Dynamic Inventory Systems," Working Papers 2008-23, School of Economic Sciences, Washington State University.

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