Understanding Cash Flow Risk
64 Pages Posted: 26 Jun 2017 Last revised: 15 Dec 2020
Date Written: December 11, 2020
Theory has recently shown that cash flow risk depends on the exposure of firms to short- and long-term cash flow shocks and the correlation between these shocks, with a higher correlation reducing risk. We provide granular estimates of these parameters for Compustat firms using a new filter that uses only cash flow data and the theoretical restrictions imposed by a canonical cash flow model. We show empirically that the estimated parameters have first-order effects on firms’ policies, that firms with a higher estimated correlation between shocks implement riskier policies, and that the sign of this correlation determines that cash flow sensitivity of cash as predicted by theory.
Keywords: cash flow risk, permanent and transitory shocks, liquidity management
JEL Classification: G31, G32, G35
Suggested Citation: Suggested Citation