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Market Timing, Investment, and Risk Management

  • Patrick Bolton
  • Hui Chen
  • Neng Wang

Firms face uncertain financing conditions and are exposed to the risk of a sudden rise in financing costs during financial crises. We develop a tractable model of dynamic corporate financial management (cash accumulation, investment, equity issuance, risk management, and payout policies) for a financially constrained firm facing time-varying external financing costs. Firms value financial slack and build cash reserves to mitigate financial constraints. However, uncertainty about future financing opportunities also induce firms to rationally time the equity market, even if they have no immediate needs for cash. The stochastic financing conditions have rich implications for investment and risk management: (1) investment can be decreasing in financial slack; (2) firms may invest less as expected future financing costs fall; (3) investment-cash sensitivity, marginal value of cash, and firm's risk premium can all be non-monotonic in cash holdings; (4) speculation (as opposed to hedging) can be value-maximizing for financially constrained firms.

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File URL: http://www.nber.org/papers/w16808.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16808.

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Date of creation: Feb 2011
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Publication status: published as Bolton, Patrick & Chen, Hui & Wang, Neng, 2013. "Market timing, investment, and risk management," Journal of Financial Economics, Elsevier, vol. 109(1), pages 40-62.
Handle: RePEc:nbr:nberwo:16808
Note: AP CF
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