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Precautionary Saving in a Financially-Constrained Firm

Andrew B. Abel, Stavros Panageas

NBER Working Paper No. 26628
Issued in January 2020
NBER Program(s):Corporate Finance Program, Economic Fluctuations and Growth Program

For a firm that cannot raise external funds, cash on hand serves as precautionary saving. We derive a closed-form expression for the target level of cash on hand in the presence of persistent cash flows. Contrary to conventional wisdom, a mean-preserving increase in the volatility of cash flow can decrease this target. Over the set of admissible parameter values the average impact of volatility on the target is zero. Endogenous selection, reflecting termination of firms that run out of cash, leads to a positive average impact of volatility on the target level of cash, consistent with empirical findings.

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Document Object Identifier (DOI): 10.3386/w26628

 
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