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Optimal cash holdings under heterogeneous beliefs
Author(s) -
Jarrow Robert,
Krishenik Andrey,
Minca Andreea
Publication year - 2018
Publication title -
mathematical finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.98
H-Index - 81
eISSN - 1467-9965
pISSN - 0960-1627
DOI - 10.1111/mafi.12148
Subject(s) - creditor , debt , monetary economics , stackelberg competition , cash , economics , cash flow , business , incentive , investment (military) , financial system , finance , microeconomics , politics , political science , law
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 to increase the debt capacity of the firm.