Corporate liquidity and risk management with time-inconsistent preferences |
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| Institution: | 1. LEE & Economics Dept., University Jaume I, 12071 Castellón, Spain;2. School of Agriculture Policy and Development, University of Reading, UK and LEE & Economics Dept., University Jaume I, Castellón, Spain;3. Political Science Dept., University of Crete and Institute of Applied & Computational Mathematics, Foundation for Research and Technology Hellas and Dusseldorf Institute for Competition Economics, University of Dusseldorf, Germany;4. Economics and Finance Subject Group, Portsmouth Business School, University of Portsmouth, Richmond Building, Portland Street, Portsmouth, Hampshire PO1 3DE, UK;5. Economics Dept., University of Crete, Greece;1. School of Statistics, Faculty of Economics and Management, East China Normal University, Shanghai 200241, China;2. School of Mathematical Sciences, Qufu Normal University, Qufu 273165, Shandong, China |
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| Abstract: | This paper extends the model of corporate liquidity and risk management with limited commitment by incorporating time-inconsistent preferences. With respect to the firm's liquidity w = W∕K, it predicts that in the presence of time-inconsistency, the entrepreneur optimally responds by lowering the maximal debt capacity, over-consuming, under-investing and reducing both the idiosyncratic and systematic volatility of w. When disentangling the entrepreneur's belief with regard to future selves' time-inconsistent behavior, as a result of sophistication effect, the sophisticated entrepreneur reduces the endogenous debt capacity, invests less, decreases consumption, engages less in financial hedging and allocates even smaller liquid assets in the market portfolio than naive entrepreneur. |
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| Keywords: | Time-inconsistent preferences Limited commitment Debt capacity Idiosyncratic risk Systematic risk D81 E22 G30 |
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