Corporate liquidity and risk management with time-inconsistent preferences

Bo Liu, Yingjie Niu and Yuhua Zhang

Economic Modelling, 2019, vol. 81, issue C, 295-307

Abstract: This paper extends the model of corporate liquidity and risk management with limited commitment by incorporating time-inconsistent preferences. With respect to the firm's liquidity w = W∕K, it predicts that in the presence of time-inconsistency, the entrepreneur optimally responds by lowering the maximal debt capacity, over-consuming, under-investing and reducing both the idiosyncratic and systematic volatility of w. When disentangling the entrepreneur's belief with regard to future selves' time-inconsistent behavior, as a result of sophistication effect, the sophisticated entrepreneur reduces the endogenous debt capacity, invests less, decreases consumption, engages less in financial hedging and allocates even smaller liquid assets in the market portfolio than naive entrepreneur.

Keywords: Time-inconsistent preferences; Limited commitment; Debt capacity; Idiosyncratic risk; Systematic risk (search for similar items in EconPapers)
JEL-codes: D81 E22 G30 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:81:y:2019:i:c:p:295-307

DOI: 10.1016/j.econmod.2019.05.007

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