Idiosyncratic Corporate Liquidity and Equity Returns

This paper examines the effect corporate liquidity may impose on the equity returns. We find that firms with more cash have higher expected stock returns because they are riskier. In general, firms with higher corporate liquidity tend to be smaller, financially distressed, have higher beta, more volatile cash flows and more financial constraints. In addition, the positive impact of corporate liquidity on stock returns is stronger for firms with volatile cash flows and financial constraints. We also show that corporate liquidity contains risk information different from that in size and value factors. The paper provides empirical evidence to support the precautionary motive of holding cash, and suggests that corporate liquidity may serve as a proxy for the cash flow risk and financial constraint risk of the firms