Is the relationship between investment and conditional cash flow volatility ambiguous, asymmetric or both?


  • We thank an anonymous referee, Robert Faff, Olga Dodd, Graeme Guthrie, Martin Lally and Stefanie Schurer for their comments. We also thank seminar participants at the 2012 Victoria University of Wellington Finance Workshop, the 2012 Auckland Finance Meeting, the 2013 New Zealand Finance Colloquium and the 2013 Accounting and Finance Conference. We thank Robert Kieschnick, who provided comments while a Stephen Turnovsky Visiting Scholar at the School of Economics and Finance at Victoria University of Wellington. All remaining errors are our own.
  • *Correction added on 8 October 2013 after first publication online on 1 August 2013: The hypotheses have now been renumbered.


We investigate the effect of cash flow volatility on investment. Our evidence suggests that financially constrained firms decrease investment (i) when experiencing persistently high volatility; (ii) when experiencing both high volatility and negative cash flow growth realisations; and (iii) when holding low cash levels and experiencing both high volatility and a negative cash flow growth realisations. In financially unconstrained firms, the above effects are either not found or are of relatively low economic importance. Overall, our findings lend support to the financial flexibility literature and tend to contradict predictions of the real options literature.