Precautionary Savings with Risky Assets: When Cash Is Not Cash

89 Pages Posted: 3 Nov 2013 Last revised: 28 May 2016

Ran Duchin

University of Washington - Michael G. Foster School of Business

Thomas Gilbert

University of Washington - Department of Finance and Business Economics

Jarrad Harford

University of Washington

Christopher M. Hrdlicka

University of Washington - Michael G. Foster School of Business

Date Written: May 27, 2016

Abstract

We show that U.S. industrial firms invest heavily in non-cash, risky financial assets such as corporate debt, equity, and mortgage-backed securities. Risky assets represent 40% of firms’ financial portfolios, or 6% of total book assets. We present a formal model to assess the optimality of risky financial investments. Consistent with the model’s predictions, risky assets are concentrated in financially unconstrained firms that hold large financial portfolios. Further, they are undertaken by poorly governed firms and discounted by 13-22% compared to safe assets. We conclude that this activity represents an unregulated asset management industry of more than $1.5 trillion, questioning the traditional boundaries of nonfinancial firms.

Keywords: Cash, Precautionary Savings, Investment Securities, Risk, Liquidity, SFAS 157, Fair Value, Taxes

JEL Classification: G32, G34

Suggested Citation

Duchin, Ran and Gilbert, Thomas and Harford, Jarrad and Hrdlicka, Christopher M., Precautionary Savings with Risky Assets: When Cash Is Not Cash (May 27, 2016). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2348415 or http://dx.doi.org/10.2139/ssrn.2348415

Ran Duchin

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

Thomas Gilbert

University of Washington - Department of Finance and Business Economics ( email )

Box 353200
Seattle, WA 98195
United States
206-616-7184 (Phone)

HOME PAGE: http://faculty.washington.edu/gilbertt/

Jarrad Harford

University of Washington ( email )

Box 353226
Seattle, WA 98195-3226
United States
206-543-4796 (Phone)
206-543-7472 (Fax)

HOME PAGE: http://faculty.washington.edu/jarrad/

Christopher M. Hrdlicka (Contact Author)

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195
United States
206.616.0332 (Phone)
206.542.7472 (Fax)

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