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Cash holdings, risk, and expected returns

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  • Palazzo, Berardino
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    Abstract

    In this paper I develop and empirically test a model that highlights how the correlation between cash flows and a source of aggregate risk affects a firm's optimal cash holding policy. In the model, riskier firms (i.e., firms with a higher correlation between cash flows and the aggregate shock) are more likely to use costly external funding to finance their growth option exercises and have higher optimal savings. This precautionary savings motive implies a positive relation between expected equity returns and cash holdings. In addition, this positive relation is stronger for firms with less valuable growth options. Using a data set of US pubic companies, I find evidence consistent with the model's predictions.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 104 (2012)
    Issue (Month): 1 ()
    Pages: 162-185

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    Handle: RePEc:eee:jfinec:v:104:y:2012:i:1:p:162-185

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: Expected equity returns; Precautionary savings; Growth options;

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    Cited by:
    1. Heitor Almeida & Murillo Campello & Igor Cunha & Michael S. Weisbach, 2013. "Corporate Liquidity Management: A Conceptual Framework and Survey," NBER Working Papers 19502, National Bureau of Economic Research, Inc.
    2. Berardino Palazzo, 2013. "Net leverage, risk, and credit spreads," 2013 Meeting Papers 436, Society for Economic Dynamics.
    3. Bessler, Wolfgang & Drobetz, Wolfgang & Haller, Rebekka & Meier, Iwan, 2013. "The international zero-leverage phenomenon," Journal of Corporate Finance, Elsevier, vol. 23(C), pages 196-221.
    4. Patrick Bolton & Hui Chen & Neng Wang, 2011. "Market Timing, Investment, and Risk Management," NBER Working Papers 16808, National Bureau of Economic Research, Inc.

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