Abstract
In this paper, we develop a dynamic model that captures the interaction between a firm’s cash reserves, the risk management policy and the profitability of a non-predictable irreversible investment opportunity. We consider a firm that has assets in place generating a stochastic cash-flow stream. The firm has a non-predictable growth opportunity to expand its operation size by paying a sunk cost. When the opportunity is available, the firm can finance it either by cash or by costly equity issuance. We provide an explicit characterization of the firm strategy in terms of investment, hedging, equity issuance and dividend distribution.
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Stephane Villeneuve benefited from the financial support of the Market Risk and Creation Value an initiative from SCOR under the aegis of Fondation du risque.
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Villeneuve, S., Warin, X. Optimal Liquidity management and Hedging in the presence of a non-predictable investment opportunity. Math Finan Econ 8, 193–227 (2014). https://doi.org/10.1007/s11579-013-0110-0
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DOI: https://doi.org/10.1007/s11579-013-0110-0