Financing constraints and inventories

This paper puts forward the existence of financing constraints as a possible explanation for two main empirical regularities about inventories; that (i) inventory investment is procyclical, and that (ii) the inventory-sales relationship displays highly positive serial correlation. There are no costs shocks, and in the numerical computations demand shocks are assumed to be serially uncorrelated. When financing constraints are not binding, the model predicts that the firm's optimal inventory investment is counter-cyclical. However, this prediction is reversed for a firm with binding financing constraints. Moreover, some persistence in the inventory-sales relationship is also generated by the model.