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Cash-Hedged Stock Returns

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  • Chase P. Ross
  • Landon J. Ross
  • Sharon Y. Ross

Abstract

This paper studies firms’ cash holdings and the implications for asset prices and financial stability. Corporate cash piles vary across companies and over time, and cash holdings are important for financial stability because of their value in crises. Firms’ cash holdings earn low returns that are correlated across firms. Thus, the asset pricing results are important both for investors who are managing a portfolio’s risk and policymakers concerned about sources of vulnerability. We show how investors can hedge out the cash on firms’ balance sheets when making portfolio choices. Cash generates variation in beta estimates, and we decompose stock betas into components that depend on the firm’s cash holding, return on cash, and cash-hedged return. Common asset pricing premia have large implicit cash positions, and portfolios of cash-hedged premia often have higher Sharpe ratios because of the correlation between firms’ cash returns. We show the value of a dollar increased in 2020, and firms hold cash because they are riskier. (Working Paper no. 22-03).

Suggested Citation

  • Chase P. Ross & Landon J. Ross & Sharon Y. Ross, 2022. "Cash-Hedged Stock Returns," Working Papers 22-03, Office of Financial Research, US Department of the Treasury.
    • Handle: RePEc:ofr:wpaper:22-03
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    References listed on IDEAS

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