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After a market panic: cash is king

Garrett C.C. Smith (Department of Finance, Florida Atlantic University, Boca Raton, Florida, USA)

Managerial Finance

ISSN: 0307-4358

Article publication date: 6 May 2014

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Abstract

Purpose

The purpose of this paper is to examine the effects of financial flexibility as represented by excess cash holdings and debt capacity upon firm returns after periods of high market uncertainty.

Design/methodology/approach

Days of high uncertainty are identified from 1987-2011 using the VXO Index (implied volatility of the S&P 100) yielding approximately 45,000 firm events. The main variables of interest are excess cash (Duchin et al., 2010) and debt capacity. Two financial constraint indexes are used as controls in a cross-sectional OLS regression.

Findings

The precautionary value of cash during and after times of uncertainty is beneficial. A positive relationship exists for periods of up to two years following the initial day of high uncertainty. Positive BHRs exist on a zero-cost trade investing in a portfolio of high excess cash firms and shorting a portfolio of cash constrained firms. The value of excess debt capacity, on the other hand, is harder to discern; positive profits are obtainable on a zero-cost trade while regression estimates are typically insignificant on average.

Originality/value

This paper expands the financial flexibility literature by testing the effects of financial flexibility on returns following days of high market uncertainty.

Keywords

Citation

C.C. Smith, G. (2014), "After a market panic: cash is king", Managerial Finance, Vol. 40 No. 5, pp. 506-534. https://doi.org/10.1108/MF-07-2013-0166

Publisher

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Emerald Group Publishing Limited

Copyright © 2014, Emerald Group Publishing Limited

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