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Aggregate Risk and the Choice between Cash and Lines of Credit

  • Acharya, Viral V
  • Almeida, Heitor
  • Campello, Murillo

We model corporate liquidity policy and show that aggregate risk exposure is a key determinant of how firms choose between cash and bank credit lines. Banks create liquidity for firms by pooling their idiosyncratic risks. As a result, firms with high aggregate risk find it costly to get credit lines and opt for cash in spite of higher opportunity costs and liquidity premium. Likewise, in times when aggregate risk is high, firms rely more on cash than on credit lines. We verify these predictions empirically. Cross-sectional analyses show that firms with high exposure to systematic risk have a higher ratio of cash to credit lines and face higher spreads on their lines. Time-series analyses show that firms' cash reserves rise in times of high aggregate volatility and in such times credit lines initiations fall, their spreads widen, and maturities shorten. Also consistent with the mechanism in the model, we find that exposure to undrawn credit lines increases bank-specific risks in times of high aggregate volatility.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8913.

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Date of creation: Mar 2012
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Handle: RePEc:cpr:ceprdp:8913
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  1. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  2. Evan Gatev & Philip E. Strahan, 2006. "Banks' Advantage in Hedging Liquidity Risk: Theory and Evidence from the Commercial Paper Market," Journal of Finance, American Finance Association, vol. 61(2), pages 867-892, 04.
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  4. Adriano Rampini & Andrea Eisfeldt, 2005. "Financing Shortfalls and the Value of Aggregate Liquidity," 2005 Meeting Papers 889, Society for Economic Dynamics.
  5. Viral V. Acharya & Heitor Almeida & Murillo Campello, 2005. "Is Cash Negative Debt? A Hedging Perspective on Corporate Financial Policies," NBER Working Papers 11391, National Bureau of Economic Research, Inc.
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  12. Anil K. Kashyap & Raghuram Rajan & Jeremy C. Stein, 1999. "Banks as Liquidity Providers: An Explanation for the Co-Existence of Lending and Deposit-Taking," NBER Working Papers 6962, National Bureau of Economic Research, Inc.
  13. Ivashina, Victoria & Scharfstein, David, 2010. "Bank lending during the financial crisis of 2008," Journal of Financial Economics, Elsevier, vol. 97(3), pages 319-338, September.
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  17. Lins, Karl V. & Servaes, Henri & Tufano, Peter, 2010. "What drives corporate liquidity? An international survey of cash holdings and lines of credit," Journal of Financial Economics, Elsevier, vol. 98(1), pages 160-176, October.
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