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Optimal Liquidity management and Hedging in the presence of a non-predictable investment opportunity

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  • Villeneuve, Stéphane
  • Warin, Xavier
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    Abstract

    In this paper, we develop a dynamic model that captures the interaction between a firm’s cash reserves, the risk management policy and the profitability of a non-predictable irreversible investment opportunity. We consider a firm that has assets in place generating a stochastic cash-flow stream. The firm has a non-predictable growth opportunity to expand its operation size by paying a sunk cost. When the opportunity is available, the firm can finance it either by cash or by costly equity issuance. We provide an explicit characterization of the firm strategy in terms of investment, hedging, equity issuance and dividend distribution.

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    File URL: http://basepub.dauphine.fr/xmlui/bitstream/123456789/12476/1/OptimalLiquidity_MAFE_sept2013-1.pdf
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    Bibliographic Info

    Paper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/12476.

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    Date of creation: 2013
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    Publication status: Published in Mathematics and Financial Economics, 2013
    Handle: RePEc:dau:papers:123456789/12476

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    Related research

    Keywords: Liquidity management; Singular control problem; One-dimensional free boundary problem; Maximum principle;

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    1. Décamps, Jean-Paul & Mariotti, Thomas & Rochet, Jean-Charles & Villeneuve, Stéphane, 2008. "Free Cash-Flow, Issuance Costs and Stock Price Volatility," IDEI Working Papers 518, Institut d'Économie Industrielle (IDEI), Toulouse.
    2. Bates, Thomas W. & Kahle, Kathleen M. & Stulz, Rene M., 2007. "Why Do U.S. Firms Hold So Much More Cash Than They Used To?," Working Paper Series 2006-17, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    3. Décamps, Jean-Paul & Villeneuve, Stéphane, 2005. "Optimal Dividend Policy and Growth Option," IDEI Working Papers 369, Institut d'Économie Industrielle (IDEI), Toulouse.
    4. Glenn W. Boyle & Graeme A. Guthrie, 2003. "Investment, Uncertainty, and Liquidity," Journal of Finance, American Finance Association, vol. 58(5), pages 2143-2166, October.
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