Real Option Component of Cash Holdings, Business Cycle, and Stock Returns

32 Pages Posted: 21 Nov 2014 Last revised: 10 May 2019

See all articles by Jiun-Lin Chen

Jiun-Lin Chen

University of Adelaide; Financial Research Network (FIRN)

Z. Tingting Jia

University of Arkansas at Little Rock

Ping-Wen Sun

Minjiang University - Newhuadu Business School

Date Written: December 16, 2014

Abstract

Corporate managers tend to preserve cash with an expectation of a worse economy while spend cash to exercise growth opportunities with a favorable economic condition. We hypothesize that there exists a real option component of aggregate corporate cash holdings, serving both functions of precautionary saving and exercising growth options. Consistent with our hypothesis, the empirical results show that this component increases when the real GDP declines while decreasing when the real GDP increases. Stocks with returns declining more to a shock to the real option component of aggregate cash holdings earn higher future returns. Moreover, our results show that stock returns of firms with higher cash holdings positively comove with the shock to the real option component of aggregate cash holdings, suggesting investors prefer to hold firms with higher cash holdings when the economy is bad.

Keywords: cash holdings, real option, factor model, GDP growth rate

JEL Classification: D92, E32, G12, G31, G32

Suggested Citation

Chen, Jiun-Lin and Jia, Zi and Sun, Ping-Wen, Real Option Component of Cash Holdings, Business Cycle, and Stock Returns (December 16, 2014). Asian Finance Association (AsianFA) 2015 Conference Paper, Available at SSRN: https://ssrn.com/abstract=2528940 or http://dx.doi.org/10.2139/ssrn.2528940

Jiun-Lin Chen

University of Adelaide ( email )

No 233 North Terrace, School of Commerce
Adelaide, South Australia 5005
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

Zi Jia

University of Arkansas at Little Rock ( email )

Little Rock, AR 72201
United States

Ping-Wen Sun (Contact Author)

Minjiang University - Newhuadu Business School ( email )

Fujian
China

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