Cash holdings and oil price uncertainty exposures

Abstract This paper investigates the role of cash holdings in controlling the negative risk from oil price uncertainty. We develop a dynamic model and find that firms with oil-linked assets in place are more likely to experience cash flow shortfalls, which affect their future investments and lead to additional costs and losses. We define these potential costs and losses as negative oil price uncertainty exposures. Firms with negative oil price uncertainty exposures must hold cash in case such costs and losses are realized. Further analysis shows that the relationship between oil price uncertainty exposures and cash holdings is heterogeneous with respect to firm-specific characteristics. An additional unit of cash holding is more valuable to firms with severe financial constraints or low existing liabilities because it increases the firm's ability to counter the adverse effects of oil price uncertainty. Using a sample of all non-state-owned, A-share listed manufacturing firms in China from 2008 to 2018, we find data that support the implications of our model.