Operating Hedge and Gross Profitability Premium

Leonid Kogan, Jun Li and Harold Zhang

No 30241, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: E44 G12 (search for similar items in EconPapers)
Date: 2022-07
New Economics Papers: this item is included in nep-fmk
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Published as LEONID KOGAN & JUN LI & HAROLD H. ZHANG, 2023. "Operating Hedge and Gross Profitability Premium," The Journal of Finance, vol 78(6), pages 3387-3422.

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