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Cash Holdings and Credit Risk

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  • Acharya, Viral V.
  • Davydenko, Sergei A.
  • Strebulaev, Ilya

Abstract

Intuition suggests that firms with higher cash holdings are safer and should have lower credit spreads. Yet empirically, the correlation between cash and spreads is robustly positive and higher for lower credit ratings. This puzzling finding can be explained by the precautionary motive for saving cash. In our model endogenously determined optimal cash reserves are positively related to credit risk, resulting in a positive correlation between cash and spreads. In contrast, spreads are negatively related to the ``exogenous'' component of cash holdings that is independent of credit risk factors. Similarly, although firms with higher cash reserves are less likely to default over short horizons, endogenously determined liquidity may be related positively to the longer-term probability of default. Our empirical analysis confirms these predictions, suggesting that precautionary savings are central to understanding the effects of cash on credit risk.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7125.

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Date of creation: Jan 2009
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Handle: RePEc:cpr:ceprdp:7125

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Keywords: Credit spreads; Default; Liquidity; Precautionary savings;

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Cited by:
  1. M. Peiris & Alexandros Vardoulakis, 2013. "Savings and default," Economic Theory, Springer, vol. 54(1), pages 153-180, September.
  2. Baghai, Ramin & Servaes, Henri & Tamayo, Ane, 2011. "Have Rating Agencies Become More Conservative? Implications for Capital Structure and Debt Pricing," CEPR Discussion Papers 8446, C.E.P.R. Discussion Papers.
  3. 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.
  4. Wang, Jia & Meric, Gulser & Liu, Zugang & Meric, Ilhan, 2009. "Stock market crashes, firm characteristics, and stock returns," Journal of Banking & Finance, Elsevier, vol. 33(9), pages 1563-1574, September.

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