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Dynamic corporate investment and liquidity management under model uncertainty

Author

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  • Wu, Yaoyao
  • Yang, Jinqiang
  • Zou, Zhentao

Abstract

We extend the model of dynamic investment and liquidity management for financially constrained firms (Bolton et al., 2011) by incorporating model uncertainty. Our theoretical model predicts that different from traditional business risk model uncertainty and concerning about model misspecification have ambiguous effects on the investment behavior and liquidity management, which depends on the firm’s liquidity measured by firm’s cash–capital ratio w=W∕K. It shows that model uncertainty induces the firm to under-invest when the firm has sufficient cash. However, the firm prefers over-investing as its liquidity is essentially low. Moreover, an increasing in model uncertainty accelerates firm’s payout while an increasing in business risk will delay the firm to pay out cash. Finally, it shows that model uncertainty significantly lowers a firm’s average q and marginal q as well as marginal value of liquidity.

Suggested Citation

  • Wu, Yaoyao & Yang, Jinqiang & Zou, Zhentao, 2017. "Dynamic corporate investment and liquidity management under model uncertainty," Economics Letters, Elsevier, vol. 155(C), pages 9-13.
    • Handle: RePEc:eee:ecolet:v:155:y:2017:i:c:p:9-13
    DOI: 10.1016/j.econlet.2017.03.006
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    References listed on IDEAS

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    Cited by:

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    6. Yaoyao Wu & Jinqiang Yang & Zhentao Zou, 2018. "Ambiguity sharing and the lack of relative performance evaluation," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 66(1), pages 141-157, July.
    7. Niu, Yingjie & Zhou, Lei & Zou, Zhentao, 2019. "A model of capacity choice under Knightian uncertainty," Economics Letters, Elsevier, vol. 174(C), pages 189-194.
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    9. Luo, Pengfei & Tian, Yuan, 2022. "Investment, payout, and cash management under risk and ambiguity," Journal of Banking & Finance, Elsevier, vol. 141(C).

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    More about this item

    Keywords

    Model uncertainty; Investment; Liquidity management; q theory;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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