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Discussion Paper Details

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Title: Aggregate Risk and the Choice between Cash and Lines of Credit

Author(s): Viral V. Acharya, Heitor Almeida and Murillo Campello

Publication Date: March 2012

Keyword(s): asset beta, bank lines of credit, cash holdings, liquidity management, loan maturity, loan spreads and systemic risk

Programme Area(s): Financial Economics

Abstract: We model corporate liquidity policy and show that aggregate risk exposure is a key determinant of how firms choose between cash and bank credit lines. Banks create liquidity for firms by pooling their idiosyncratic risks. As a result, firms with high aggregate risk find it costly to get credit lines and opt for cash in spite of higher opportunity costs and liquidity premium. Likewise, in times when aggregate risk is high, firms rely more on cash than on credit lines. We verify these predictions empirically. Cross-sectional analyses show that firms with high exposure to systematic risk have a higher ratio of cash to credit lines and face higher spreads on their lines. Time-series analyses show that firms' cash reserves rise in times of high aggregate volatility and in such times credit lines initiations fall, their spreads widen, and maturities shorten. Also consistent with the mechanism in the model, we find that exposure to undrawn credit lines increases bank-specific risks in times of high aggregate volatility.

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Bibliographic Reference

Acharya, V, Almeida, H and Campello, M. 2012. 'Aggregate Risk and the Choice between Cash and Lines of Credit'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=8913