Market Timing, Investment, and Risk Management / Patrick Bolton, Hui Chen, Neng Wang.

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Bolton, Patrick

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w16808.Publication details: Cambridge, Mass. National Bureau of Economic Research 2011.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: 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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Working Paper	Biblioteca Digital	Colección NBER	nber w16808 (Browse shelf(Opens below))	Not For Loan

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Previous	nber w16805 Capital Controls: Myth and Reality - A Portfolio Balance Approach /	nber w16806 The Evolution of Comparative Advantage: Measurement and Welfare Implications /	nber w16807 Has Consumption Inequality Mirrored Income Inequality? /	nber w16808 Market Timing, Investment, and Risk Management /	nber w16809 Industrial Catching Up in the Poor Periphery 1870-1975 /	nber w1681 A Pigovian Rule for the Optimum Provision of Public Goods /	nber w16810 Advances in Consumption-Based Asset Pricing: Empirical Tests /	Next

February 2011.

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.