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Cash holdings, risk, and expected returns

  • Palazzo, Berardino
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    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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    File URL: http://www.sciencedirect.com/science/article/pii/S0304405X11002856
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    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
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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