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.
strategic default; payoff dominant equilibrium; constrained optimal stopping time;
Stéphane Villeneuve, and Xavier Warin, “Optimal Liquidity Management and Hedging in the presence of a non predictable investment opportunity”, TSE Working Paper, n. 12-266, January 23, 2012.
Mathematics and Financial Economics, vol. 8, n. 2, March 2014, pp. 193–227