Surfing the Cycle: Cyclical Investment Opportunities and Firms' Risky Financial Assets

68 Pages Posted: 17 Jan 2022

See all articles by Teng Huang

Teng Huang

Luiss Guido Carli University - Department of Economics and Finance

Stefano Sacchetto

IESE Business School

Date Written: January 17, 2022

Abstract

This paper studies why non-financial firms invest in risky financial assets. Within a dynamic corporate finance model with macroeconomic fluctuations, we show that firms can use risky financial assets to transfer liquidity from states with low aggregate investment opportunities to states with high aggregate investment opportunities. Specifically, when investment funding demand is more pro-cyclical than profits and external financing is costly, risky financial assets with pro-cyclical returns can be more valuable than risk-free assets in matching internal funding and investment opportunities. Based on U.S. firm data scraped from SEC 10-K filings, we find empirical evidence consistent with this mechanism: (1) time-serially, the value of risky financial assets is positively correlated with the corporate investment rate; (2) cross-sectionally, firms with more pro-cyclical investment funding demand in excess of profits hold more risky financial assets.

Keywords: Business Cycles, Financing Frictions, Cash Holdings, Risky Financial Assets, Machine Learning

JEL Classification: E32, G11, G32

Suggested Citation

Huang, Teng and Sacchetto, Stefano, Surfing the Cycle: Cyclical Investment Opportunities and Firms' Risky Financial Assets (January 17, 2022). Available at SSRN: https://ssrn.com/abstract=4010801 or http://dx.doi.org/10.2139/ssrn.4010801

Teng Huang (Contact Author)

Luiss Guido Carli University - Department of Economics and Finance ( email )

Viale Romania, 32
Rome, 00197
Italy

Stefano Sacchetto

IESE Business School ( email )

08034 Barcelona
Spain
+34 93 253 6461 (Phone)

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