Optimal Cash Holdings Under Heterogeneous Beliefs
39 Pages Posted: 14 Jun 2014 Last revised: 8 Jul 2015
Date Written: June 13, 2014
Abstract
This paper explores a one-period model for a firm that finances its operations through debt provided by heterogeneous creditors. Creditors differ in their beliefs about the firm's investment outcomes. We show the existence of Stackelberg equilibria in which the firm holds cash reserves in order to provide incentives for pessimistic creditors to invest in the firm. We find interest rates and cash holdings to be complementary tools for increasing debt capacity. In markets with a high concentration of capital across a small interval of pessimistic creditors or by a few large creditors, cash holdings is the preferred tool that can lead to an upward jump in the debt capacity of the firm.
Keywords: Funding liquidity, Cash balances, Debt capacity, Optimal investment under market frictions, Stackelberg equilibrium, Heterogeneous creditors
JEL Classification: C72, D70, D81, G20, G32
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