The Real Option Value of Cash
Forthcoming in the Review of Finance
67 Pages Posted: 12 Dec 2010 Last revised: 30 Jan 2013
Date Written: August 2012
This paper focuses on the idea that cash has a real option value and it presents an explicit valuation framework of cash holdings in the context of a capacity expansion option. The model characterizes the optimal dynamic cash retention policy, the value of internal funds and it provides a model implied regression specification based on simulated data. Results imply that high cash flow volatility decreases the value of cash and that optimal cash retention can actually delay investment relative to the case of full outside financing. Both novel implications are confirmed by subsequent empirical tests.
Keywords: Real Options, Cash Holdings, Payout Policy, Investment
JEL Classification: G31, G32, G35
Suggested Citation: Suggested Citation