Cash Holdings and Credit Risk

Viral V. Acharya (), Sergei A. Davydenko and Ilya Strebulaev

No 7125, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Intuition suggests that firms with higher cash holdings are safer and should have lower credit spreads. Yet empirically, the correlation between cash and spreads is robustly positive and higher for lower credit ratings. This puzzling finding can be explained by the precautionary motive for saving cash. In our model endogenously determined optimal cash reserves are positively related to credit risk, resulting in a positive correlation between cash and spreads. In contrast, spreads are negatively related to the ``exogenous'' component of cash holdings that is independent of credit risk factors. Similarly, although firms with higher cash reserves are less likely to default over short horizons, 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 (search for similar items in EconPapers)
JEL-codes: G32 G33 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-rmg
Date: 2009-01
View list of references

Downloads: (external link)
http://www.cepr.org/pubs/dps/DP7125.asp (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:cpr:ceprdp:7125

Ordering information: This working paper can be ordered from
http://www.cepr.org/pubs/dps/DP7125.asp

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers
Address: Centre for Economic Policy Research, 53--56 Great Sutton Street, London EC1V 0DG
Series data maintained by ().