Working Paper: NBER ID: w26628
Authors: Andrew B. Abel; Stavros Panageas
Abstract: For a firm that cannot raise external funds, cash on hand serves as precautionary saving. We derive a closed-form expression for the target level of cash on hand in the presence of persistent cash flows. Contrary to conventional wisdom, a mean-preserving increase in the volatility of cash flow can decrease this target. Over the set of admissible parameter values the average impact of volatility on the target is zero. Endogenous selection, reflecting termination of firms that run out of cash, leads to a positive average impact of volatility on the target level of cash, consistent with empirical findings.
Keywords: Precautionary saving; Financial constraints; Cash management; Volatility; Markov process
JEL Codes: E21; G31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in cash flow volatility (G19) | decrease in target level of cash on hand (E41) |
| increase in cash flow volatility (G19) | increase in probability of needing external finance (G32) |
| positive serial correlation of cash flows (C10) | decrease in target level of cash on hand (E41) |
| increase in cash flow volatility (G19) | average impact of volatility on target level of cash is zero (G19) |
| higher volatility (G17) | firms more likely to terminate (J63) |