Optimal Cash Holdings Under Heterogeneous Beliefs

39 Pages Posted: 14 Jun 2014 Last revised: 8 Jul 2015

See all articles by Robert A. Jarrow

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management

Andrey Krishenik

Cornell University - School of Operations Research and Industrial Engineering

Andreea Minca

Cornell University

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

Suggested Citation

Jarrow, Robert A. and Krishenik, Andrey and Minca, Andreea, Optimal Cash Holdings Under Heterogeneous Beliefs (June 13, 2014). Available at SSRN: https://ssrn.com/abstract=2449972 or http://dx.doi.org/10.2139/ssrn.2449972

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Department of Finance
Ithaca, NY 14853
United States
607-255-4729 (Phone)
607-254-4590 (Fax)

Andrey Krishenik

Cornell University - School of Operations Research and Industrial Engineering ( email )

Ithaca, NY
United States

Andreea Minca (Contact Author)

Cornell University ( email )

222 Rhodes Hall
Ithaca, NY NY 14853
United States

HOME PAGE: http://people.orie.cornell.edu/acm299/

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