Inventory Management with Trade Policy Uncertainty

Abstract

AbstractThis paper develops a theoretical model to describe how exporting firms manage their inventory stocks in response to an exogenous trade policy uncertainty shock. Using firm‐level data from China Industrial Enterprise Database and China Customs Database on inventory and exports over the period around China's WTO accession, we show that a reduction in trade policy uncertainty significantly increased exporting firms' inventory holdings. The result was robust to various robustness checks. This effect was found to be stronger for private and foreign firms than state‐owned enterprises and mainly driven by firms from the coastal region. We also found that the reduction in trade policy uncertainty increased the frequency and the average volume of export transactions, and that this was the mechanism behind the effect. This paper helps to understand exporting firms' optimal inventory problem arising from trade‐policy uncertainty and shocks.