Corporate Money Demand
50 Pages Posted: 19 Apr 2018
Date Written: April 19, 2018
We document a hump-shaped relation between interest rates and corporate cash demand. We rationalize this finding in a model where firms use internal cash and external debt to finance investment. Risky debt rates rise endogenously with the risk-free rate. Because firms accumulate cash to obtain better borrowing rates, optimal cash holdings also rise with the risk-free rate. However, income effects and foregone interest earnings imply a negative relation. The first mechanism dominates at low interest rates, while the second dominates at high interest rates. The model quantitatively matches several features of the data and reproduces the empirical hump-shaped cash-interest relation.
Keywords: Corporate Cash Holdings, Interest Rates, Debt Cost, Financial Frictions
JEL Classification: E41, E43, G12, G32
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