Cash-Hedged Stock Returns

Abstract

Corporate cash piles vary across companies and over time. A firm’s cash holding is an implicit position in a low-return asset that is correlated across firms. Cash generates variation in beta estimates. We show how investors can hedge out the cash on firms’ balance sheets when making portfolio choices. We write stock betas as components that depend on the firm’s cash holding, return on cash, and cash-hedged return. Common asset pricing premia—size, value, and momentum—have large implicit cash positions. Portfolios of cash-hedged premia often have higher Sharpe ratios because firms’ cash returns are correlated.

Keywords: cross-section of expected returns, cash, risk factor, size, value, momentum

JEL Classification: G12