Cash Holdings and Credit Risk

46 Pages Posted: 22 Mar 2007 Last revised: 20 Aug 2012

Viral V. Acharya

New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Sergei A. Davydenko

University of Toronto - Finance Area

Ilya A. Strebulaev

Stanford University - Graduate School of Business; National Bureau of Economic Research

Multiple version iconThere are 3 versions of this paper

Date Written: August 1, 2012

Abstract

Intuition suggests that firms with higher cash holdings should be 'safer' and have lower credit spreads. Yet empirically, the correlation between cash and spreads is robustly positive. This puzzling finding can be explained by the precautionary motive for saving cash, which in our model causes riskier firms to accumulate higher cash reserves. In contrast, spreads are negatively related to the part of cash holdings that is not determined by credit risk factors. Similarly, although firms with higher cash reserves are less likely to default in the short term, endogenously determined liquidity may be related positively to the longer-term probability of default. Our empirical analysis confirms these predictions, suggesting that precautionary savings are central to understanding the effects of cash on credit risk.

Keywords: Credit spreads, Default, Liquidity, Precautionary savings

JEL Classification: G32, G33

Suggested Citation

Acharya, Viral V. and Davydenko, Sergei A. and Strebulaev, Ilya A., Cash Holdings and Credit Risk (August 1, 2012). Western Finance Association 2008 Meetings Paper; Rock Center for Corporate Governance at Stanford University Working Paper No. 123. Available at SSRN: https://ssrn.com/abstract=972508 or http://dx.doi.org/10.2139/ssrn.972508

Viral V. Acharya

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Sergei A. Davydenko (Contact Author)

University of Toronto - Finance Area ( email )

Toronto, Ontario M5S 3E6
Canada

Ilya A. Strebulaev

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

HOME PAGE: http://faculty-gsb.stanford.edu/strebulaev/

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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