Cash Holding, Ambiguity Aversion, And Investment Puzzles

We consider a real options model with ambiguity to investigate how cash holdings and ambiguity aversion affect a firm’s dynamic investments. First, we prove a unique positive ambiguity coefficient exists when ambiguity exceeds it such that entrepreneurs believe the project is “too valueless to invest in.” Second, the coupons demanded by creditors increase with ambiguity, and cash holdings reduce the ambiguity premium. Our research provides a new explanation as to why companies abandon investment and hold more cash under the influence of the COVID-19 pandemic.