Market Timing, Investment, and Risk Management

55 Pages Posted: 28 Feb 2011

See all articles by Patrick Bolton

Patrick Bolton

Columbia Business School - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Hui Chen

Massachusetts Institute of Technology; National Bureau of Economic Research (NBER)

Neng Wang

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: February 2011

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.

Suggested Citation

Bolton, Patrick and Chen, Hui and Wang, Neng, Market Timing, Investment, and Risk Management (February 2011). NBER Working Paper No. w16808. Available at SSRN: https://ssrn.com/abstract=1768566

Patrick Bolton (Contact Author)

Columbia Business School - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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European Corporate Governance Institute (ECGI)

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Hui Chen

Massachusetts Institute of Technology ( email )

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National Bureau of Economic Research (NBER) ( email )

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Neng Wang

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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