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Investment, Debt and Risk Management in a Context of Uncertain Returns to Investment

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  • Marcello Spanò
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    Abstract

    In a context of uncertain returns to investment, a firm may face increasing costs of borrowing and uncertain value of its internal finance. Froot, Scharfstein, and Stein (1993) develop a framework where the firm can hedge against the fluctuations of its cash flow, in order to better coordinate investment and financing decisions. This work moves within this framework and finds an approximated analytical solution that allows one to better understand the properties of the optimal hedging strategy, as well as the effects of hedging on firm's investing and financing behaviour. Numerical simulations of the non closed-form optimal solution are also obtained to validate the approximation, which is thus supported by numerical evidence.

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    File URL: http://www.york.ac.uk/media/economics/documents/discussionpapers/2001/0107.pdf
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    Paper provided by Department of Economics, University of York in its series Discussion Papers with number 01/07.

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    Handle: RePEc:yor:yorken:01/07

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    Keywords: Hedging; investment; debt; volatility; internal funds.;

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    1. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
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