Uncertainty of Uncertainty and Firm Cash Holdings

35 Pages Posted: 12 Feb 2021

See all articles by John W. Goodell

John W. Goodell

University of Akron - Department of Finance, College of Business Administration

Abhinav Goyal

University College Cork

Andrew Urquhart

ICMA Centre, Henley Business School

Date Written: December 11, 2020

Abstract

We examine the impact on firm cash holdings of uncertainty of uncertainty, measured as the ex post volatility of economic policy uncertainty. Using the news-based index developed by Baker, Bloom, and Davis (2016) for twenty-two countries, we find that, when there is greater volatility of economic uncertainty, firms hold more cash. Our results are robust to controlling for a host of firm-level and country-level factors. Consistent with Baker, Bloom, and Davis (2016), we consider that less economic policy uncertainty is associated with more investment; and so the real-option value of cash is sensitive to the possibility of a future desirability of investment. Therefore, when there is greater expected volatility of uncertainty, measured under rational expectations as the recent ex post volatility of uncertainty, firms will hold more cash. We also find that the volatility of economic policy uncertainty is much more economically significant in determining firm cash holdings than economic policy uncertainty itself. Therefore, our paper not only adds to the literature on uncertainty and cash holdings, but also, importantly, to the limited literature in finance on the impact of uncertainty of uncertainty.

Keywords: Economic policy uncertainty, Uncertainty of uncertainty, Cash holdings, Real options, Transaction costs

JEL Classification: G32, D8

Suggested Citation

Goodell, John W. and Goyal, Abhinav and Urquhart, Andrew, Uncertainty of Uncertainty and Firm Cash Holdings (December 11, 2020). Journal of Financial Stability, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3749000

John W. Goodell

University of Akron - Department of Finance, College of Business Administration ( email )

259 S. Broadway
Akron, OH 44325
United States

Abhinav Goyal (Contact Author)

University College Cork ( email )

O'Rahilly Building
College Road
Cork
Ireland
+353 (0)21 490 2839 (Phone)

Andrew Urquhart

ICMA Centre, Henley Business School ( email )

University of Reading
Whiteknights
Reading, Berkshire RG6 6BA
United Kingdom

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