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Cash Holdings and Credit Risk

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

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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16995.

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Date of creation: Apr 2011
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Publication status: published as “Cash Holdings and Credit Risk” with Sergei Davydenko and Ilya Strebulaev , 2012, Review of Financial Studies , 25(12), 3572 - 3609
Handle: RePEc:nbr:nberwo:16995

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Cited by:
  1. Almeida, Heitor & Campello, Murillo & Cunha, Igor & Weisbach, Michael S., 2013. "Corporate Liquidity Management: A Conceptual Framework and Survey," Working Paper Series, Ohio State University, Charles A. Dice Center for Research in Financial Economics 2013-15, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
  2. Wang, Jia & Meric, Gulser & Liu, Zugang & Meric, Ilhan, 2009. "Stock market crashes, firm characteristics, and stock returns," Journal of Banking & Finance, Elsevier, Elsevier, vol. 33(9), pages 1563-1574, September.
  3. M. Peiris & Alexandros Vardoulakis, 2013. "Savings and default," Economic Theory, Springer, Springer, vol. 54(1), pages 153-180, September.
  4. Baghai, Ramin & Servaes, Henri & Tamayo, Ane, 2011. "Have Rating Agencies Become More Conservative? Implications for Capital Structure and Debt Pricing," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8446, C.E.P.R. Discussion Papers.

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