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Optimal Liquidity management and Hedging in the presence of a non-predictable investment opportunity

Villeneuve, Stéphane; Warin, Xavier (2014), Optimal Liquidity management and Hedging in the presence of a non-predictable investment opportunity, Mathematics and Financial Economics, 8, 2, p. 193-227. http://dx.doi.org/10.1007/s11579-013-0110-0

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Type
Article accepté pour publication ou publié
Date
2014
Journal name
Mathematics and Financial Economics
Volume
8
Number
2
Publisher
Springer
Pages
193-227
Publication identifier
Metadata
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Author(s)
Villeneuve, Stéphane
Warin, Xavier
Abstract (EN)
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.
Subjects / Keywords
Liquidity management; Singular control problem; One-dimensional free boundary problem; Maximum principle
JEL
G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
G31 - Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
G33 - Bankruptcy; Liquidation
G35 - Payout Policy