Uncertainty Determinants of Corporate Liquidity

This paper investigates the link between the optimal level of non–financial firms’ liquid assets and uncertainty. We develop a partial equilibrium model of precautionary demand for cash that shows that firms are likely to change their liquidity ratio in response to changes in uncertainty. We test this proposition using a panel of non–financial US firms drawn from COMPUSTAT quarterly database covering the period 1991-2001. The results show that firms increase their liquidity ratios when macroeconomic uncertainty increases. We demonstrate that our results are robust with respect to the inclusion of detrended index of leading indicators and interest rates.