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Room P3.10, Mathematics Building
Stéphane Villeneuve, Toulouse School of Economics, University of Toulouse
Corporate cash policy with liquidity and profitability risks
We develop a dynamic model of a firm facing both liquidity and
profitability concerns. This leads us to study and to solve
explicitly a bi-dimensional control problem where the two state
variables are the controlled cash reserves process and the belief
process about the firm’s profitability. Our model encompasses
previous studies and provides new predictions for corporate cash
policy. The model predicts a positive relationship between cash
holdings and beliefs about the firm’s profitability, a
non-monotonic relationship between cash holdings and the volatility
of the cash flows as well as a non-monotonic relationship between
cash holdings and the risk of profitability. This yields novel
insights on the firm’s default policy and on the relationship
between volatility of stock prices and the level of stock.