Product Price Risk and Liquidity Management: Evidence from the Electricity Industry
Charles A. Dice Center Working Paper No. 2017-12
57 Pages Posted: 16 May 2017 Last revised: 27 Aug 2018
Date Written: August 25, 2018
Product price risk is a potentially important factor for firms’ liquidity management. A natural place to evaluate the impact of this risk on liquidity management is the electricity industry, since in 32 countries, producing firms sell electricity in volatile wholesale markets. Empirically, higher volatility of electricity prices leads to an increase in cash holdings, and this effect is robust to instrumenting for price risk using weather volatility. Cash increases more with price risk in firms using inflexible production and those that cannot easily hedge electricity prices through derivative markets, indicating that operating flexibility and hedging are substitutes for liquidity management.
Keywords: Electricity price volatility, cash holdings, weather volatility, operating flexibility, hedging
JEL Classification: G30, G32
Suggested Citation: Suggested Citation