Aggregate Risk and the Choice between Cash and Lines of Credit
85 Pages Posted: 1 Aug 2012
There are 3 versions of this paper
Aggregate Risk and the Choice between Cash and Lines of Credit
Aggregate Risk and the Choice between Cash and Lines of Credit
Aggregate Risk and the Choice between Cash and Lines of Credit
Date Written: July 31, 2012
Abstract
We model corporate liquidity policy and show that aggregate risk exposure is a key determinant of how firms choose between cash and bank credit lines. Banks create liquidity for firms by pooling their idiosyncratic risks. As a result, firms with high aggregate risk find it costly to get credit lines and opt for cash in spite of higher opportunity costs and liquidity premium. Likewise, in times when aggregate risk is high, firms rely more on cash than on credit lines. We verify these predictions empirically. Cross-sectional analyses show that firms with high exposure to systematic risk have a higher ratio of cash to credit lines and face higher costs on their lines. Time-series analyses show that firms’ cash reserves rise in times of high aggregate volatility and in such times credit lines initiations fall, their spreads widen, and maturities shorten. Also consistent with the mechanism in the model, we find that exposure to undrawn credit lines increases bank-specific risks in times of high aggregate volatility.
Keywords: bank lines of credit, cash holdings, liquidity management, systematic risk, loan spreads, loan
JEL Classification: G21, G31, G32, E22, E5
Suggested Citation: Suggested Citation
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