Corporate Policies with Permanent and Transitory Shocks
60 Pages Posted: 2 Mar 2016
Date Written: March 2, 2016
We model the financing, cash holdings, and hedging policies of a firm facing financing frictions and subject to permanent and transitory cash flow shocks. We show that permanent and transitory shocks generate distinct, sometimes opposite, effects on corporate policies and use the model to develop a rich set of empirical predictions. In our model, correlated permanent and transitory shocks imply less risk, lower cash savings, and a drop in the value of credit lines. The composition of cash-flow shocks affects the cash-flow sensitivity of cash, which can be positive or negative. Optimal hedging of permanent and transitory shocks may involve opposite positions.
Keywords: Financing frictions; cash holdings; risk management; credit lines; permanent and transitory shocks
JEL Classification: G31, G32, G35
Suggested Citation: Suggested Citation