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Financial Analysts Journal Volume 69 Number 1 2013 CFA Institute

Change in Cash-Holding Policies and Stock Return Predictability in the Cross Section
William R. Sodjahin
The author found that stocks with a positive change in company cash holdings have significantly higher riskadjusted returns than stocks with a negative change in cash holdings (CCH). Moreover, the return predictive power of CCH is (1) distinct from the effect of cash holdings (CH), (2) absent among cash-rich companies, (3) stronger among small-cap stocks, and (4) limited to non-January months. The CCH anomaly appears to be more contaminated than the CH effect by mispricing.

everal studies have focused extensively on the determinants of a companys cash holdings and the holdings time-series properties over time.1 Only recently, however, have excess cash holdings been linked to stock returns (Simutin 2010) and a precautionary savings policy to expected returns (Palazzo 2012). Simutin documented a positive relationship between excess cash and subsequent stock returns. Palazzo showed a positive correlation between cash-holding policies and average realized returns. Intuitively, both authors argued that riskier companies facing costly external funding maintain higher levels of cash to finance their growth, and thus, a companys cash holdings can be linked to risk and expected returns. Because risk is time varying and a companys investment opportunities are ever changing, a change in cash-holding policy can also be viewed as a proxy for the arrival of new investment opportunities (or the disappearance of existing opportunities). This dynamic implies a positive relationship between a change in cashholding policy and subsequent stock returns as compensation for the risk that accompanies a new investment opportunity. Note that because of the time to build that characterizes new investments, there is a lag between the arrival of the new investment opportunity and its undertaking or realization (see, e.g., Bar-Ilan and Strange 1996; Pindyck 1991; MacRae 1989; Wheaton 1987). Changes in cash holdings are, by definition, different from the level of cash holdings (Palazzo 2012) or excess cash holdings (Simutin 2010) in the sense that a company can increase its cash holdings and still have a low cash-holding level or a company can decrease its cash holdings and still William R. Sodjahin is a research scientist at the Stern School of Business, New York University.

maintain an excess cash-holding level. In my study, I focused on the variation in the cash holdings of companies as a signal for the emergence or disappearance of risky investment opportunities. Discussion of findings.The objective of my study was threefold. First, I investigated how changes in companies cash holdings are related to subsequent returns. In other words, can changes in cash holdings (CCH) predict stock returns? Using both FamaMacBeth (1973) cross-sectional regressions (standard and risk adjusted) and portfolio analysis, I explored the return predictability of CCH, which is the cash-to-assets ratiolevel of cash holdings (CH)minus the lagged cash-toassets ratio (see, e.g., Bates, Kahle, and Stulz 2009). I found that CCH has a strong, unconditional return predictive power.2 This power remains strong after controlling for such standard stock return predictors as size, book-to-market, momentum, asset growth, illiquidity ratio, and idiosyncratic volatility in both cross-sectional regressions and portfolio analysis. For example, the FamaFrench (1993) three-factor alpha (the Carhart [1997] fourfactor alpha) of the strategy that goes long the top CCH quintile and short the bottom CCH quintile is 0.27% (0.20%) a month; this spread in alphas is strongly significant and substantially higher for non-January months, at 0.34% (0.27%). Importantly, a CCH-based factor-mimicking portfolio has a Sharpe ratio of 0.15, higher than that of the market factor (0.09) or the SMB and HML factors (0.09 and 0.13, respectively) of Fama and French (1993) and only slightly lower than that of the momentum factor (0.16). For the non-January months, a CCH-based factor-mimicking portfolio has a much higher Sharpe ratio (0.21), which is still higher than that of the market, SMB, and HML factors (0.08, 0.04, and 0.10, respectively) and very close to that of the momentum factor (0.22).
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Second, how distinct is the CCH effect from the CH effect? Does the CCH effect exist for both cashconstrained and cash-rich companies? Palazzo (2012) showed that high-CH companies have more growth opportunities. From a rational viewpoint, I hypothesized that CCH reflects changes in future investment opportunities. I confirmed this hypothesis by showing empirically that companies that increase their cash holdings have significantly higher (vis--vis companies that decrease their cash holdings) subsequent investment growth for up to two years. Moreover, the cash holdings of cash-rich companies may be less elastic to variations in future risky investment opportunities than the cash holdings of cash-constrained companies. Intuitively, a traditionally cash-rich company will not indefinitely increase its cash holdings in response to the arrival of new investment opportunities (because the level of its cash holdings is already high), as opposed to a traditionally low-cash company, which is more likely to adjust its cash-holding policy to changes in its risky investment opportunities. Therefore, the CCH effect is expected to be stronger or exclusively concentrated among cash-constrained (low-cash) companies. I found evidence consistent with these predictions. In particular, I observed that CCH remains significant after controlling for CH (and vice versa) in cross-sectional regressions and portfolio analysis. Moreover, the spreads in subsequent returns from a longshort strategy based on CCH are concentrated exclusively in the universe of cashconstrained (low-CH) companies. Furthermore, my results show that the CCH effect is stronger among smaller-cap companies. Third, the CCH and CH effects may not be completely rational. Hence, I gauged the extent to which CCH and CH can, at least in part, be attributed to mispricing caused by various investors behavioral biases.3 In other words, I studied the implications of arbitrage costs for both the CCH and the CH effects. Shleifer and Vishny (1997) suggested that arbitrage is risky, costly, and limited. Because arbitrageurs are generally poorly diversified, any nonsystematic risk would add considerably to the total risk of their overall portfolios and hinder their arbitrage activities. And because the costs of arbitrage may outweigh its benefits, it would be difficult for investors to fully arbitrage away any gain associated with a companys CCH or CH effect so long as the effect is driven by mispricing. Thus, if the CCH or CH effect is due to mispricing, it should be concentrated among stocks that are more difficult to arbitrage (that have a higher arbitrage risk). Arbitrage costs comprise transaction costs and holding costs (see Pontiff 2006). Following Li and Sullivan (2011),
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among others, I focused on idiosyncratic volatility (IVol) as a proxy for the holding-cost component of arbitrage costs.4 Indeed, transaction costs were unlikely to be weighted significantly as strong limits to arbitrage because my CCH and CH portfolios were rebalanced only annually. In short, the extent to which the CCH and CH effects are concentrated in high-IVol stocks reflects the degree to which mispricing is important in explaining these effects. My findings reveal the pervasiveness of both CCH and CH anomalies across IVol groups, though the CCH effect is substantially higher among high-IVol stocks. I found that the CCH effect is more contaminated (though only partly) by mispricing than is the CH effect. Finally, I documented a surprisingly negative CCH effect for January months and showed that this effect is entirely driven by mispricing.

Data Description and Analysis


I obtained stock return data from the CRSP Monthly Stock File and accounting data from the CRSP/Compustat Merged Industrial Annual File, via Wharton Research Data Services (WRDS). I included in my sample (July 1965December 2010) all ordinary common shares (share codes 10 and 11 in CRSP) traded on the NYSE, Amex, and NASDAQ with available accounting and return data. I excluded regulated utilities (SIC codes 49004999) and financial companies (SIC codes 60006999) and also excluded observations concerning suspended, halted, or nonlisted shares (i.e., exchange codes lower than 1 and higher than 3). Following prior research (see, e.g., Li and Sullivan 2011), I focused on companies with a December fiscal year end. I obtained one-month T-bill rates from Kenneth Frenchs website.5 The main variable of interest in my study was the change in cash holdings (CCH) of a company, measured as the companys cash-to-asset ratio (Compustats item CHE divided by Compustats item AT) minus the lagged cash-to-asset ratio (see, e.g., Bates, Kahle, and Stulz 2009; Palazzo 2012). LogAT is the natural log of the companys total assets. BM is the natural log book-to-market equity as the log book equity for the fiscal year ending in t minus the log market equity at the end of December in year t. Book equity is the Compustat book value of stockholders equity (Compustat annual item SEQ) plus balance-sheet deferred taxes (item TXDB) and investment tax credit (item ITCI, if available) minus the book value of preferred stock. To estimate the book value of preferred stock, I used redemption (item PSTKRV), liquidation (item PSTKL), or par value (item PSTK), in that order and depending on availability. Market equity is the
2013 CFA Institute

Change in Cash-Holding Policies and Stock Return Predictability in the Cross Section

CRSP price per share times the number of shares outstanding (SHROUT). I measured IVol (idiosyncratic volatility) as the standard deviation of the residual values from the FamaFrench three-factor model by regressing daily excess stock returns on relevant factors. Excess returns are in excess of the one-month T-bill rate. I used daily stock and factor returns in the prior JulyJune period to estimate IVol for each month. I winsorized all accounting variables at the 1st and 99th percentiles to mitigate the effect of outliers. Panel A of Table 1 reports summary statistics of the sample. The mean of the key variable (CCH) is negative (0.4%), with a standard deviation of 8.40%, which indicates a relatively important variation in CCH across companies and over time. The CCH distribution is skewed toward companies that reduce their cash holdings. The mean of CCH is four times larger (in absolute value) than the median. CH has a larger mean in absolute value (16%), with a larger standard deviation, than CCH. CH is skewed toward companies with high cash holdings but is less skewed than CCH. The mean of

CH is about two times the median. LogAT, BM, and IVol display less-skewed patterns. Panel B presents the samples paired, crosssectional Spearmans rank correlations between the key variables in Panel A. The change in cash holdings is not strongly correlated with the level of cash holdings. The correlation coefficient between CCH and CH is not very close to zero but is less than 25% (0.21). The correlation between CCH and LogAT is positive but very weak (0.02). The correlation between CCH and BM is also positive and very weak (0.01). In comparison, the correlations between CH and LogAT and between CH and BM are negative and greater (0.23 and 0.19, respectively). As expected from the literature (see, e.g., Li and Zhang 2010), the greatest correlation is the one between IVol and LogAT (0.64). In short, the correlation matrix reveals that large-asset companies tend to have a low cash-holding ratio, a positive change in cash holdings, a low book-to-market ratio, and low idiosyncratic volatility. Panel C reports future investment ratios and investment growth for years t, t + 1, t + 2, and t +

Table 1.  Summary Statistics, July 1965December 2010


Mean A. Descriptive statistics CCH CH LogAT BM IVol 0.004 0.157 5.003 0.615 3.369 CCH B. Correlation matrix (Spearman) CCH CH LogAT BM IVol 1.00 0.21 0.02 0.01 0.02 1.00 0.23 0.19 0.12 Investment Ratio Year t Low CCHt (< 0) Middle CCHt ( 0) High CCHt (> 0) High low t-Statistic 0.29 0.21 0.23 0.06 8.82 Year t+1 0.25 0.20 0.23 0.02 2.44 Year t+2 0.23 0.20 0.24 0.01 1.06 Year t+3 0.22 0.20 0.22 0.00 0.09 Year t 0.31 0.12 0.10 0.21 10.35 1.00 0.04 0.64 1.00 0.09 Investment Growth Year t+1 0.11 0.09 0.19 0.08 4.00 Year t+2 0.08 0.08 0.16 0.08 4.98 Year t+3 0.13 0.09 0.12 0.01 0.57 1.00 0.084 0.201 2.025 0.953 2.332 CH 0.001 0.072 4.855 0.569 2.725 LogAT 0.086 0.010 2.458 1.776 1.360 BM 0.073 0.450 7.779 0.514 6.153 IVol Standard Deviation Median 10th 90th

C. Change in cash holdings, future investment ratio, and investment growth

Note: The t-statistics are derived from the NeweyWest (1987) procedure with one lag.

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3 by change in cash holdings of year t (CCHt) for companies that survived for the entire three subsequent years. Following Xing (2008), I measured the investment ratio as the ratio of capital expenditures (Compustat item CAPX) to the net book value of fixed assets (Compustat item PPENT) at the beginning of each fiscal year. Investment growth is the growth rate for a companys capital expenditures. The summary statistics in Panel C show that companies that increase their cash holdings have significantly lower contemporaneous investment growth (compared with companies that decrease their cash holdings), but they have significantly higher subsequent investment growth for up to two years. Moreover, these companies have very significantly lower contemporaneous investment ratios and less significantly lower investment ratios in the first subsequent year. In the second and third subsequent years, the differences between the investment ratios of companies that increase their cash holdings and the investment ratios of companies that reduce their cash holdings become insignificantly different from zero. Overall, these results suggest that CCH does indeed signal future investment growth and can proxy for changes in future risky investment opportunities.

TXDB) and investment tax credit (item ITCI, if available) minus the book value of preferred stock. To estimate the book value of preferred stock, I used redemption (item PSTKRV), liquidation (item PSTKL), or par value (item PSTK), in that order and depending on availability. Market equity is the CRSP price per share times the number of shares outstanding (SHROUT). MOM is the log prior-12-month returns (with a one-month gap between the holding period and the current month). AG is the percentage change in total assets (Compustats item AT) from fiscal year t 2 to fiscal year t 1. Illiq is the average ratio of absolute daily return to trading value over the month, computed as follows: rd ,t 1 Dt Illiqti = , (1) i Di t d =1 Priced volumed ,t where
i rd ,t
i

Change in Cash Holdings and Subsequent Returns


I then examined FamaMacBeth cross-sectional regressions and conducted a portfolio analysis in order to test the CCH effect on returns. FamaMacBeth Cross-Sectional Regressions. I investigated the cross-sectional relation between the change in a companys cash holdings and subsequent stock returns. CCH for a fiscal year end t 1 becomes available for monthly FamaMacBeth (1973) regressions the seventh month (July of year t) after the fiscal year end. To begin my analysis, I conducted standard FamaMacBeth regressions of excess returns (risk unadjusted) on CCH alone and then on CCH while controlling for such predictors of stock returns as market capitalization (ME), book-to-market (BM), momentum (MOM), asset growth (AG; see Cooper, Gulen, and Schill 2008), illiquidity (Illiq; see Amihud 2002), and monthly idiosyncratic volatility (IVolm; see Ang, Hodrick, Xing, and Zhang 2006). ME is the log market capitalization at the end of June in year t, and BM is the log book-to-market equity as the log book equity for the fiscal year end t 1 minus the log market equity at the end of December in year t 1. Book equity is the Compustat book value of stockholders equity (Compustat annual item SEQ) plus balance-sheet deferred taxes (item
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= the return for stock i on day d of month t Priced volume = the priced daily trading volume D = the number of days in the month for which data are available IVolm is the monthly standard deviation of the residual values from the FamaFrench three-factor model, obtained by regressing daily excess stock returns on relevant factors and defined as var i t

( )

in the following equation:6 (2)

rti r f = i + iMKT MKTt + iSMB SMBt +


where

iHML HMLt

i t,

= the daily return of stock i rf = the risk-free rate MKT = the excess return on the market portfolio SMB = the FamaFrench (1993) size factor HML = the FamaFrench (1993) value factor To check for robustness, I also conducted the risk-adjusted FamaMacBeth (FM) regressions by replacing excess returns with risk-adjusted returns as dependent variables. I based the risk adjustment on the FamaFrench (1993) three-factor model and the Carhart (1997) four-factor model (an extension of the FamaFrench model that contains an additional momentum factor). I used the Dimson (1979) procedure with one lag to adjust for thin trading (see, e.g., Brennan, Chordia, and Subrahmanyam 1998). I estimated the factor loadings by using a 60-month rolling window.

rti

2013 CFA Institute

Change in Cash-Holding Policies and Stock Return Predictability in the Cross Section

Specifically, I estimated the following equation:

t +1 = 0,t + 1,t CCH t + 2,t MEt + 3,t BM t r + 4,t MOM t + 5,t AGt + 6,t Illiqt + 7,t IVolmt + t +1 ,
(3)

t +1 is the excess returns, risk-adjusted returns where r based on the FamaFrench three-factor model (FF3RA), or risk-adjusted returns based on the

Carhart four-factor model (FF4RA). The results of the cross-sectional regressions are reported in Table 2. The reported coefficients are the time-series averages from monthly cross-sectional regressions, and the t-statistics are based on the time series of monthly coefficient estimates. I used the Newey West (1987) procedure to correct for potential serial correlation. Model 1 presents the results of the FM regression based on excess returns (ER), which

Table 2.  FamaMacBeth Cross-Sectional Regressions of Monthly Percentage Excess Returns and Risk-Adjusted Returns on Changes in Cash Holdings, July 1965December 2010 (t-statistics in parentheses)
Model 1 2 3 4 INT 0.92 (3.06) 0.83 (2.76) 3.05 (4.87) 2.74 (4.36) B. Dependent variable = FF3RA 5 6 7 8 0.15 (2.32) 0.04 (0.59) 2.61 (7.15) 2.48 (6.95) C. Dependent variable = FF4RA 9 10 11 12 0.20 (3.17) 0.12 (1.82) 2.40 (6.62) 2.31 (6.63) *Significant at the 10% level. **Significant at the 5% level. ***Significant at the 1% level. 0.96*** (2.86) 0.59** (2.37) 1.24*** (3.40) 0.63** (2.41) 0.12*** (4.36) 0.11*** (4.45) 0.03 (0.40) 0.01 (0.21) 0.20 (1.36) 0.18 (1.23) 0.40*** (4.65) 0.30*** (3.79) 0.29*** (3.32) 0.28*** (3.16) 0.40*** (10.61) 0.41*** (10.84) 0.93*** (2.77) 0.74*** (3.00) 1.12*** (3.12) 0.90*** (3.36) 0.16*** (5.78) 0.15*** (5.78) 0.12** (1.99) 0.07 (1.36) 0.09 (0.62) 0.07 (0.45) 0.40*** (4.30) 0.29*** (3.43) 0.28*** (3.52) 0.29*** (3.38) 0.35*** (9.73) 0.35*** (9.93) 0.93*** (2.80) 0.94*** (3.00) CCH 1.25*** (3.21) 0.47 (1.22) 0.15*** (3.72) 0.14*** (3.39) 0.16*** (2.08) 0.22*** (3.32) 0.30* (1.75) 0.27 (1.55) 0.56*** (6.39) 0.46*** (5.83) 0.23*** (2.80) 0.27*** (3.27) 0.20*** (5.15) 0.20*** (5.39) CH ME BM MOM AG Illiq IVolm A. Dependent variable = ER

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includes only the CCH as an explanatory variable. For comparison, Model 2 regresses ER on CH (the level of cash holdings) alone. Models 3 and 4 are versions of Models 1 and 2, respectively, that control for the various stock return predictors in Equation 3. The dependent variables for Models 5 through 12 are risk-adjusted returns (FF3RA and FF4RA). Model 1 shows that CCH is a significant predictor of future stock returns. As expected, the coefficient on CCH is positive and statistically significant (at the 1% level), with a t-statistic of 3.21. CCH remains a strong stock return predictor (still significant at the 1% level) after controlling for stock return predictors in Equation 3. In contrast, the unconditional effect of CH is insignificant. Indeed, the coefficient on CH is insignificant in Model 2. However, the coefficient on CH becomes strongly significant when the control variables are included. In line with prior literature, the control variables display the expected signs and are all strongly significant in Models 3 and 4, except for MOM, which is significant only at the 10% level in Model 3 and insignificant in Model 4. The results from the risk-adjusted Fama MacBeth regressions confirm the strong predictive power of CCH. The coefficient on CCH is significant at the 1% level in all specifications (see Models 5, 7, 9, and 11). Contrary to Model 2 (risk-unadjusted regressions), the coefficient on CH in Models 6 and 10 (risk-adjusted regressions) is significant. The CH effect becomes weaker when the risk adjustment is based on the Carhart four-factor model. The coefficient on CH is significant at the 5% level in both specifications (Models 10 and 12). To make sure that my previous results were not driven by any biases arising from the January effect, I repeated the analysis in Table 2 without January returns. Indeed, Keim (1983) documented that much of the abnormal returns to small companies occur in January; moreover, Li and Zhang (2010) showed that the abnormal corporate investment effect of Titman, Wei, and Xie (2004) is driven entirely by the January effect. The results of the FM regressions without the January returns are presented in Table 3. The CCH effect becomes even stronger in all specifications when January returns are excluded. In contrast, the CH effect slightly weakens, especially when the risk adjustment is based on the Carhart four-factor model. (See Appendix A for the results of standard and riskadjusted FamaMacBeth regressions for January months only.) Portfolio Analysis. I then investigated whether sorting stocks by CCH alone or by CCH while controlling for the various company characteristics in Equation 3 generates significant variation in
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portfolio returns. The purpose of controlling for these characteristics was to examine the robustness of my results with the CCH portfolio formation strategy to various cross-sectional risk factors. For comparison, I also report the results of my CH-based portfolio analysis. Panel A of Table 4 reports various summary statistics for value-weighted quintile portfolios sorted on the basis of CCH for all months. The first two columns are the mean and Sharpe ratio of monthly excess returns. The excess returns are measured in percentages and are calculated as the raw stock return less the risk-free rate. The columns labeled -CAPM, -FF3, and -FF4 report the time-series alphas of these portfolios relative to the capital asset pricing model (CAPM), the FamaFrench three-factor model, and the Carhart four-factor model (the FamaFrench model augmented with the momentum factor), respectively. In addition, Panel A reports the excess returns and alphas for a zero-cost longshort spread, or trading profitability, of the CCH trading strategy. This portfolio represents the difference between the highestand lowest-ranked quintiles. Panel C replicates Panel A for non-January months only. Consistent with the results of FamaMacBeth cross-sectional regressions, the monthly excess returns increase, nearly monotonically, from 0.68% (0.30% for nonJanuary months) for Portfolio 1 to 0.90% (0.62% for non-January months) for Portfolio 5. The differences between Portfolios 5 and 1 are strongly significant at the 1% level. Moreover, higher-CCH portfolios exhibit significantly higher CAPM, FF3, and FF4 alphas. The Gibbons, Ross, and Shanken (GRS 1989) test, which indicates the null hypothesis that all alphas of each model are jointly zero, is strongly rejected for the three models. Controlling for the market factor and the FamaFrench factors exacerbates the 51 spread (from 0.22% to 0.24% and 0.27% a month, respectively), whereas controlling for the FamaFrench and momentum factors decreases the 51 spread to 0.20%. These alpha spreads are strongly significant and substantially higher for non-January months0.34%, 0.34%, and 0.27% a month, respectively. Panel B of Table 4 reports the results of a single sort on the CH (Panel D reports the same results for non-January months only). Even though the excess returns increase monotonically across the quintile portfolios, the differences between Portfolios 5 and 1 are lower (especially for non-January months) and insignificant. These results are consistent with the results of the unconditional FM regressions in Tables 2 and 3. The spread in CAPM alphas is also very small and insignificant. The GRS test is not rejected for the CAPM. Moreover, in line with the
2013 CFA Institute

Change in Cash-Holding Policies and Stock Return Predictability in the Cross Section

Table 3.  FamaMacBeth Cross-Sectional Regressions of Monthly Percentage Excess Returns and Risk-Adjusted Returns on Changes in Cash Holdings (No January Returns), July 1965December 2010 (t-statistics in parentheses)
Model 1 2 3 4 INT 0.55 (1.80) 0.46 (1.54) 1.95 (3.10) 1.65 (2.61) B. Dependent variable = FF3RA 5 6 7 8 0.01 (0.09) 0.09 (1.27) 2.00 (5.29) 1.89 (5.02) C. Dependent variable = FF4RA 9 10 11 12 0.08 (1.36) 0.03 (0.43) 1.77 (4.36) 1.71 (4.34) *Significant at the 10% level. **Significant at the 5% level. ***Significant at the 1% level. 1.40*** (3.85) 0.47* (1.80) 1.83*** (4.50) 0.42 (1.52) 0.06** (2.04) 0.06** (2.03) 0.00 (0.00) 0.04 (0.66) 0.39** (2.53) 0.36** (2.38) 0.33*** (3.84) 0.25*** (3.10) 0.22** (2.55) 0.20** (2.26) 0.43*** (11.36) 0.44*** (11.60) 1.30*** (3.73) 0.65** (2.51) 1.68*** (4.27) 0.77*** (2.73) 0.11*** (3.89) 0.10*** (3.74) 0.12* (1.80) 0.06 (1.12) 0.33** (2.25) 0.30** (2.03) 0.30*** (3.33) 0.22*** (2.66) 0.21** (2.57) 0.21** (2.49) 0.38*** (10.73) 0.39*** (10.91) 1.31*** (3.87) 0.80** (2.42) CCH 1.86*** (4.77) 0.41 (1.03) 0.07* (1.73) 0.05 (1.32) 0.13 (1.58) 0.19*** (2.70) 0.57*** (3.20) 0.54*** (3.05) 0.50*** (5.60) 0.41*** (5.21) 0.16** (1.97) 0.18** (2.42) 0.27*** (6.80) 0.27*** (7.00) CH ME BM MOM AG Illiq IVolm A. Dependent variable = ER

results of the conditional FM regressions in Tables 2 and 3, the spreads in FF3 and FF4 alphas between Portfolios 5 and 1 are all significant at the 1% level. In addition, the GRS test is strongly rejected for both models. To make sure that the spread in average returns on the CCH portfolios observed in Table 4 was not due to the effects of various characteristics controlled for in Tables 2 and 3, I examined

the robustness of the results with the CCH portfolio formation strategy to the effects of the following characteristics: ME, BM, MOM, AG, Illiq, and IVolm. I first sorted stocks into five quintiles on the basis of each characteristic. Then, within each quintile, I sorted stocks into five quintiles on the basis of their CCH. After forming the 5 5 portfolios, I averaged the returns of each CCH quintile over the five characteristic portfolios. Therefore, these
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Table 4.  Portfolios Sorted on Capital Changes in Cash Holdings, July 1965December 2010
Mean A. Portfolios sorted on CCH 1 2 3 4 5 51 t-Statistic GRS p(GRS) B. Portfolios sorted on CH 1 2 3 4 5 51 t-Statistic GRS p(GRS) C. Portfolios sorted on CCH (non-January months) 1 2 3 4 5 51 t-Statistic GRS p(GRS) D. Portfolios sorted on CH (non-January months) 1 2 3 4 5 51 t-Statistic GRS p(GRS) 0.41 0.45 0.53 0.58 0.57 0.16 0.98 0.07 0.08 0.09 0.10 0.08 0.04 0.01 0.02 0.09 0.12 0.08 0.09 0.55 0.70 0.62 0.24 0.19 0.07 0.05 0.16 0.40 3.06 2.36 0.04 0.08 0.03 0.11 0.27 0.36 0.44 3.44 3.70 0.00 0.30 0.56 0.49 0.68 0.62 0.32 7.19 0.05 0.10 0.09 0.12 0.10 0.21 0.17 0.12 0.08 0.26 0.17 0.34 7.84 7.35 0.00 0.24 0.02 0.12 0.07 0.10 0.34 8.13 6.52 0.00 0.01 0.12 0.02 0.21 0.26 0.27 6.36 5.66 0.00 0.71 0.75 0.82 0.88 0.93 0.22 0.99 0.12 0.13 0.14 0.14 0.13 0.05 0.23 0.26 0.31 0.36 0.38 0.15 0.71 1.95 0.08 0.14 0.10 0.02 0.19 0.37 0.52 2.85 2.89 0.01 0.02 0.05 0.18 0.40 0.58 0.56 3.20 6.53 0.00 0.68 0.86 0.73 0.93 0.90 0.22 3.43 0.10 0.13 0.17 0.15 0.14 0.15 0.14 0.37 0.26 0.45 0.38 0.24 3.82 8.15 0.00 0.06 0.09 0.06 0.15 0.21 0.27 4.26 5.91 0.00 0.16 0.24 0.08 0.27 0.36 0.20 3.23 7.56 0.00 Sharpe Ratio -CAPM -FF3 -FF4

Notes: GRS denotes the Gibbons, Ross, and Shanken (1989) test, and p(GRS) is the associated p-value. Panels C and D replicate Panels A and B, respectively, for non-January months.

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2013 CFA Institute

Change in Cash-Holding Policies and Stock Return Predictability in the Cross Section

quintile CCH portfolios control for differences in each characteristic. Panel A of Table 5 reports the FF3 and FF4 alphas, the differences in FF3 and FF4 alphas between the quintile portfolios with the highest and lowest CCH, and t-statistics indicating their statistical significance. All the portfolios sorted on CCH are value weighted. The results show that controlling for characteristics reduces (or in the case of BM, increases) only slightly the magnitude of the 51 spread in portfolio FF3 and FF4 alphas. Moreover, the characteristic-controlled differences (the 51 CCH spread) are still highly significant. Thus, these characteristics cannot account for the spread in returns resulting from differences in CCH. Panel B replicates the same analysis in Panel A for CH. The results indicate that controlling for characteristics reduces or increases only slightly the magnitude of the 51 CH spread in portfolio FF3 and FF4 alphas, which all remain strongly significant. Hence, the CH effect is not explained by these characteristics either. How Distinct Are the CCH and CH Effects?Is there any source of risk related to CCH that is not captured by CH, or vice versa? Palazzo (2012) showed that high-CH companies have more growth opportunities than low-CH companies. I argued earlier that CCH signals a change in growth opportunities and provided empirical evidence to back this argument. Indeed, I showed that companies that increase their cash holdings have significantly higher (compared with companies that decrease their cash holdings) subsequent investment growth for up to two years. I then went further by explicitly testing whether the CCH effect remains after controlling for CH, and vice versa. I first ran a Fama MacBeth cross-sectional regression of subsequent returns on both CCH and CH, controlling for other characteristics. Next, using CCH and CH as characteristics, I repeated the explicit double-sorted characteristic controls (a sort on CCH while controlling for CH, and vice versa). Finally, I explored whether the CCH is pervasive across different levels of cash holdings (cash-constrained versus cash-rich companies). Table 6 reports the results of the first two stages of my analysis. The results from the FM regressions in Panel A show that the coefficient on CCH is strongly significant at the 1% level for non-January months and marginally significant at the 10% level for all months. Conversely, the coefficient on CH is marginally significant at the 10% level for nonJanuary months and significant at the 5% level for all months. Panel B reveals that controlling for CH decreases the magnitude of the CCH spread in the portfolio FF3 alpha, which does, however,

remain significant at the 1% level. The magnitude of the CCH spread in the portfolio FF4 alpha also decreases and becomes marginally significant at the 10% level. However, the results for nonJanuary months show that after controlling for CH, the magnitude of the CCH spread in portfolio FF3 and FF4 alphas is higher and remains strongly significant at the 1% level. These results suggest that the CCH effect is not explained by CH, especially when the January returns are excluded. Panel B also shows that controlling for CCH decreases the magnitude of the CH spread in portfolio FF3 and FF4 alphas, which remain significant at the 1% level. These alphas decrease further in magnitude and become significant at the 5% level for nonJanuary months. Table 7 reports the results of the third step of my analysis. Using median splits (low and high) based on the CH, I divided the sample each month. Panel A shows that the spread in alphas from a longshort strategy based on the CCH is exclusively concentrated in the universe of cashconstrained (low-CH) companies. Indeed, the CCH spread in portfolio FF4 alphas for high-CH stocks is very close to zero (0.02% for all months and 0.08% for non-January months) and insignificant. In contrast, the same alphas are much larger (0.19% for all months and 0.25% for non-January months) and strongly significant (at the 1% level for nonJanuary months and the 5% level for all months) for low-CH stocks. Thus, the CCH anomaly exists predominantly among those stocks with relatively low cash-holding levels. Panel B of Table 7 shows that the CCH effect is stronger among smaller-cap companies (those with an ME below the median). Consistent with Palazzo (2012), I found (in unreported results) that the CH effect is also stronger among smaller-cap companies. Overall, in line with a rational viewpoint, (1) both the CCH and the CH effects exist and are distinct, (2) the CCH effect is present only among cashconstrained companies, and (3) the CCH effect is stronger in the universe of smaller-cap companies more likely to face financial constraints.

Implications of Arbitrage Costs for Both CCH and CH Effects


Finally, I looked for any evidence in support of mispricing. Indeed, the CCH and CH effects may not be completely rational; recently, many papers have stressed the importance of limits to arbitrage (i.e., mispricing) in explaining investment, asset growth, and accrual anomalies (see, e.g., Li and Zhang 2010; Li and Sullivan 2011). Does the
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Table 5.  Alphas of Portfolios Sorted on Changes in Cash Holdings: Controlling for Characteristics (Robustness Checks), July 1965December 2010 (t-statistics in parentheses)
1 A. Alphas of portfolios sorted on CCH ME -FF3 -FF4 0.01 (0.13) 0.24 (2.26) BM -FF3 -FF4 0.08 (0.88) 0.15 (1.51) MOM -FF3 -FF4 0.01 (0.14) 0.18 (1.97) AG -FF3 -FF4 0.02 (0.21) 0.24 (2.37) Illiq -FF3 -FF4 0.02 (0.21) 0.21 (1.99) IVol -FF3 -FF4 0.05 (0.52) 0.17 (1.71) B. Alphas of portfolios sorted on CH ME -FF3 -FF4 0.11 (1.24) 0.05 (0.58) BM -FF3 0.16 (1.93) 0.10 (1.16) 0.01 (0.18) 0.21 (2.36) 0.40 (2.77) 0.56 (2.91) (continued) 0.09 (0.91) 0.09 (0.85) 0.08 (0.94) 0.24 (2.88) 0.21 (2.15) 0.45 (3.74) 0.46 (3.16) 0.66 (4.18) 0.56 (3.16) 0.61 (3.59) 0.03 (0.36) 0.20 (2.30) 0.07 (0.84) 0.10 (1.06) 0.15 (1.88) 0.33 (3.86) 0.19 (2.04) 0.36 (2.59) 0.24 (3.37) 0.19 (4.33) 0.07 (0.90) 0.24 (2.75) 0.04 (0.44) 0.13 (1.40) 0.13 (1.59) 0.31 (3.48) 0.24 (2.76) 0.42 (4.07) 0.26 (4.01) 0.21 (3.14) 0.03 (0.47) 0.19 (2.38) 0.02 (0.30) 0.12 (1.53) 0.04 (0.63) 0.20 (4.40) 0.27 (3.31) 0.41 (4.15) 0.25 (3.60) 0.17 (2.56) 0.03 (0.44) 0.20 (2.42) 0.05 (0.63) 0.11 (1.47) 0.09 (1.22) 0.26 (3.35) 0.18 (2.20) 0.38 (4.00) 0.19 (3.40) 0.20 (3.29) 0.09 (1.33) 0.13 (1.33) 0.07 (0.88) 0.07 (0.92) 0.11 (1.51) 0.23 (3.22) 0.26 (3.26) 0.42 (4.42) 0.34 (5.66) 0.27 (4.33) 0.08 (1.03) 0.22 (2.59) 0.04 (0.50) 0.19 (2.19) 0.18 (2.16) 0.32 (3.78) 0.27 (3.14) 0.44 (3.34) 0.26 (3.93) 0.20 (3.04) 2 3 4 5 51

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Table 5.  Alphas of Portfolios Sorted on Changes in Cash Holdings: Controlling for Characteristics (Robustness Checks), July 1965December 2010 (continued) (t-statistics in parentheses)
1 -FF4 0.01 (0.14) MOM -FF3 -FF4 0.15 (1.84) 0.00 (0.03) AG -FF3 -FF4 0.15 (1.79) 0.01 (0.16) Illiq -FF3 -FF4 0.16 (1.74) 0.02 (0.25) IVol -FF3 -FF4 0.17 (1.87) 0.01 (0.07) 0.11 (1.18) 0.09 (0.90) 0.02 (0.19) 0.22 (2.46) 0.16 (1.59) 0.38 (3.24) 0.33 (2.59) 0.50 (3.90) 0.50 (3.18) 0.49 (3.43) 0.09 (0.91) 0.10 (0.98) 0.02 (0.23) 0.20 (2.45) 0.14 (1.37) 0.37 (3.13) 0.43 (2.87) 0.65 (3.92) 0.59 (3.37) 0.63 (3.63) 0.11 (1.26) 0.08 (0.89) 0.02 (0.21) 0.21 (2.68) 0.23 (2.64) 0.43 (4.12) 0.38 (2.89) 0.53 (3.99) 0.53 (3.30) 0.52 (3.41) 0.07 (0.80) 0.11 (1.32) 0.07 (0.31) 0.17 (2.12) 0.19 (2.02) 0.39 (3.91) 0.33 (2.48) 0.52 (3.85) 0.49 (2.96) 0.52 (3.45) 2 0.07 (0.77) 3 0.17 (2.02) 4 0.41 (4.09) 5 0.58 (3.89) 51 0.59 (3.43)

predictive power of CCH and CH vary with arbitrage costs? To address this question, I divided the sample each month by using median splits (low and high) based on the idiosyncratic volatility (IVol, my proxy for arbitrage costs). Table 8 reports the alphas for the quintile portfolios and the zerocost longshort spreads (trading profitability) of the CCH and CH trading strategies. The results in Table 8 show that both the CCH and the CH effects are pervasive across the IVol groups. However, the CCH effect is substantially higher among high-IVol stocks. In particular, the abnormal return FF3 alpha (FF4 alpha) for the longshort portfolioformed as the difference between the high and low quintilesof CCH is 0.33% (0.25%) a month for the high-IVol stocks. In comparison, the monthly alphas for the low-IVol stocks are 21% and 15%, respectively.7 The monthly alphas of the CH spread portfolios across low-IVol and high-IVol stocks are all significant and very close to each other. For example, the FF3 alphas are

0.46% for low-IVol stocks and 0.45% for the subset of high-IVol stocks. How can the significant negative CCH effect for January months reported in Appendix A be explained? Can this negative effect be attributed entirely to mispricing? To answer these questions, I report in Table A2 the FF3 and FF4 CCH alphas for January months by IVol group. For comparison, I also report the FF3 and FF4 CH alphas for January months by IVol group. As these results show, the negative CCH effect is concentrated solely among stocks with high arbitrage risk (high IVol). Indeed, the spread portfolio alphas (FF3 and FF4) are significantly different from zero in the high-IVol group, whereas they are not statistically different from zero in the low-IVol group. Moreover, the differences in spread portfolio alphas between high and low IVol are statistically significant. The CH alphas on the longshort portfolio are all positive, insignificant for low-IVol stocks, and significant for high-IVol stocks. However, the differences in spread portfolio

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Table 6.  Is the CCH Effect Distinct from the CH Effect? July 1965December 2010 (t-statistics in parentheses)
Sample All months NonJanuary months INT 2.81 (4.57) CCH 0.63* (1.68) CH 0.77** (2.32) ME 0.14*** (3.53) BM 0.19*** (2.95) MOM 0.29* (1.69) AG 0.54*** (6.25) Illiq 0.23*** (2.77) IVol 0.20*** (5.23) A. FamaMacBeth regressions

1.77 (2.85)

1.08*** (2.94)

0.59* (1.75)

0.06 (1.52)

0.16** (2.22)

0.56*** (3.17)

0.48*** (5.49)

0.15* (1.92)

0.27*** (6.90)

Ranking on CCH (CH) Control B. Portfolio analysis All months CH -FF3 -FF4 CCH -FF3 -FF4 0.11 (1.21) 0.11 (1.23) 0.11 (1.33) 0.04 (0.49) NonJanuary months 0.14 (1.91) 0.30 (3.83) 0.07 (0.88) 0.08 (1.07) 0.16 (2.47) 0.30 (4.36) 0.04 (0.59) 0.20 (2.67) 0.16 (2.17) 0.29 (3.80) 0.20 (2.53) 0.37 (4.34) 0.08 (1.10) 0.23 (2.80) 0.33 (2.69) 0.47 (3.97) 0.19 (2.88) 0.12 (1.81) 0.44 (2.90) 0.43 (3.14) Alpha 1 2 3 4 5 51

CH

-FF3 -FF4

0.28 (3.69) 0.06 (0.75) 0.21 (2.35) 0.05 (0.58)

0.02 (0.29) 0.19 (2.64) 0.15 (2.02) 0.01 (0.12)

0.07 (1.23) 0.21 (3.33) 0.04 (0.61) 0.12 (1.80)

0.08 (1.25) 0.22 (3.27) 0.07 (1.08) 0.25 (3.41)

0.02 (0.27) 0.13 (1.67) 0.17 (1.49) 0.31 (2.81)

0.26 (4.19) 0.19 (3.10) 0.38 (2.37) 0.36 (2.48)

CCH

-FF3 -FF4

*Significant at the 10% level. **Significant at the 5% level. ***Significant at the 1% level.

alphas between high and low IVol are not statistically significant. Taken together, the results for the full sample and the non-January months suggest that only part of the CCH anomaly results from high barriers to arbitrage as proxied by high idiosyncratic volatilities. Moreover, the CCH effect is more contaminated (though only partly) by mispricing than is the CH effect. The difference in the FF4 alpha of the CCH spread portfolio between high and low IVol is twice the difference in the FF4 alpha of the CH spread portfolio between high and low IVol. The results for January months indicate that the surprisingly
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negative CCH effect is driven completely by mispricing (see Appendix A).

Conclusion
With this study, my contribution to the literature can be characterized as threefold. First, I provided evidence that a change in a companys cash-holding policy predicts subsequent stock returns. The abnormal returns associated with a change in cash holdings remain significant in the presence of size, bookto-market, momentum, asset growth, illiquidity, and idiosyncratic volatility. Importantly, the Sharpe ratio of a CCH-based factor-mimicking portfolio is higher
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Alphas of Portfolios Sorted on Changes in Cash Holdings and Grouped by Level of Table 7.  Cash Holdings and Market Capitalization, July 1965December 2010 (t-statistics in parentheses)
Alpha A. Ranking on CCH by CH All months Low CH -FF3 -FF4 High CH -FF3 -FF4 0.22 (2.46) 0.03 (0.29) 0.07 (0.56) 0.33 (2.49) NonJanuary months 0.03 (0.34) 0.12 (1.29) 0.26 (2.53) 0.40 (3.70) 0.11 (1.14) 0.04 (0.43) 0.32 (3.67) 0.43 (4.76) 0.04 (0.46) 0.09 (1.23) 0.34 (3.79) 0.47 (4.70) 0.04 (0.47) 0.16 (1.76) 0.16 (1.49) 0.35 (2.80) 0.26 (3.30) 0.19 (2.24) 0.09 (1.00) 0.02 (0.23) 1 2 3 4 5 51

Low CH

-FF3 -FF4

0.35 (3.87) 0.15 (1.63) 0.14 (1.15) 0.14 (1.06)

0.13 (1.57) 0.00 (0.05) 0.12 (1.31) 0.26 (2.60)

0.18 (1.86) 0.02 (0.24) 0.22 (2.72) 0.34 (3.77)

0.10 (1.15) 0.05 (0.60) 0.26 (3.12) 0.40 (4.54)

0.02 (0.37) 0.10 (1.00) 0.03 (0.31) 0.22 (1.85)

0.32 (4.05) 0.25 (3.08) 0.17 (1.93) 0.08 (0.93)

High CH

-FF3 -FF4

B. Ranking on CCH by ME All months Low ME -FF3 -FF4 High ME -FF3 -FF4 0.05 (0.35) 0.31 (1.77) 0.11 (1.43) 0.09 (1.23) NonJanuary months 0.17 (1.39) 0.34 (2.47) 0.01 (0.11) 0.13 (1.90) 0.10 (0.87) 0.27 (1.97) 0.13 (1.77) 0.02 (0.22) 0.38 (3.22) 0.58 (4.53) 0.02 (0.26) 0.11 (1.64) 0.40 (3.28) 0.60 (4.17) 0.11 (1.35) 0.24 (2.90) 0.35 (3.28) 0.29 (2.78) 0.22 (3.60) 0.15 (2.41)

Low ME

-FF3 -FF4

0.33 (2.27) 0.10 (0.61) 0.13 (1.70) 0.09 (1.27)

0.14 (1.28) 0.01 (0.09) 0.00 (0.01) 0.14 (1.93)

0.15 (1.27) 0.04 (0.30) 0.11 (1.40) 0.03 (0.40)

0.07 (0.63) 0.25 (1.99) 0.05 (0.64) 0.17 (2.47)

0.13 (1.06) 0.30 (2.19) 0.12 (1.45) 0.28 (3.38)

0.46 (4.49) 0.40 (3.78) 0.25 (3.97) 0.19 (2.84)

High ME

-FF3 -FF4

than that of the market factor or the SMB and HML factors of Fama and French (1993) and is very close to that of the momentum factor.

Second, I compared the CCH effect with the CH effect documented by Palazzo (2012). I found that (1) both effects are distinct and coexist (i.e.,
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Table 8.  Alphas of Portfolios Sorted on Changes in Cash Holdings and Grouped by Level of Idiosyncratic Volatility, July 1965December 2010 (t-statistics in parentheses)
IVol A. Ranking on CCH All months Low IVol -FF3 -FF4 High IVol -FF3 -FF4 0.00 (0.06) 0.14 (2.26) 0.14 (0.87) 0.17 (0.99) NonJanuary months 0.06 (0.85) 0.17 (2.50) 0.09 (0.65) 0.30 (1.94) 0.07 (0.87) 0.05 (0.62) 0.00 (0.02) 0.18 (1.21) 0.11 (1.63) 0.20 (2.97) 0.24 (1.90) 0.48 (3.53) 0.21 (3.05) 0.29 (4.10) 0.19 (1.25) 0.42 (2.40) 0.21 (3.74) 0.15 (2.67) 0.33 (3.33) 0.25 (2.46) Alpha 1 2 3 4 5 51

Low IVol

-FF3 -FF4

0.01 (0.16) 0.15 (2.47) 0.48 (3.34) 0.17 (1.09)

0.08 (1.08) 0.21 (2.96) 0.24 (1.83) 0.07 (0.53)

0.06 (0.71) 0.08 (1.59) 0.30 (2.47) 0.17 (1.26)

0.14 (2.04) 0.26 (3.95) 0.06 (0.49) 0.17 (1.26)

0.24 (3.32) 0.34 (4.70) 0.07 (0.47) 0.14 (0.85)

0.25 (4.21) 0.19 (3.28) 0.41 (4.46) 0.31 (3.29)

High IVol

-FF3 -FF4

B. Ranking on CH All months Low IVol -FF3 -FF4 High IVol -FF3 -FF4 0.15 (1.80) 0.01 (0.07) 0.14 (1.07) 0.07 (0.48) NonJanuary months 0.03 (0.41) 0.09 (1.14) 0.21 (1.52) 0.06 (0.37) 0.03 (0.39) 0.15 (1.93) 0.04 (0.29) 0.34 (1.96) 0.18 (2.61) 0.27 (4.08) 0.18 (1.08) 0.51 (2.47) 0.31 (4.28) 0.39 (5.14) 0.31 (1.59) 0.52 (2.72) 0.46 (4.59) 0.40 (3.86) 0.45 (2.07) 0.45 (2.22)

Low IVol

-FF3 -FF4

0.15 (1.73) 0.01 (0.11) 0.46 (3.26) 0.27 (1.87)

0.00 (0.06) 0.15 (1.89) 0.54 (3.75) 0.30 (1.94)

0.05 (0.60) 0.20 (2.41) 0.28 (2.05) 0.00 (0.01)

0.21 (2.92) 0.33 (4.78) 0.16 (1.00) 0.13 (0.73)

0.31 (4.53) 0.40 (5.32) 0.02 (0.13) 0.18 (1.01)

0.45 (4.44) 0.39 (3.39) 0.44 (1.86) 0.46 (2.14)

High IVol

-FF3 -FF4

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the abnormal returns associated with CCH remain after controlling for CH, and vice versa); (2) a significant unconditional (and conditional) relation exists between CCH and future stock returns, whereas the link between CH and future stock returns exists only when conditioning on size and book-to-market; (3) the CCH effect is negative and significant for January months, whereas the CH effect for January months remains positive and significant; (4) both the CCH and the CH effects are stronger in the universe of smaller-cap companies (more likely to face financial constraints); and (5) the CCH anomaly exists predominantly among cash-constrained companies (stocks with relatively low cash-holding levels). Third, I explored the implications of arbitrage risk for both the CCH and the CH effects and found that unlike accrual and asset growth anomalies (see Li and Sullivan 2011), both effects are pervasive across arbitrage risk groups (proxied by idiosyncratic risk) but that the CCH anomaly appears to be more influenced than the CH effect by mispricing. The surprisingly negative CCH effect found for January months is, however, driven entirely by mispricing. I am grateful for helpful comments from Kose John, Edward Altman, and Anthony Saunders.

This article qualifies for 1 CE credit.

Appendix A. Regressions and Alphas

Table A1 reports the results of standard and riskadjusted FamaMacBeth regressions for January months only. Contrary to the results for the full sample and the non-January months, the sign of the CCHreturn relationship is negative, which is the opposite direction from the rational prediction. In all specifications (both standard and risk adjusted), the coefficient on CCH is significant. Consistent with the results for the full sample and the non-January months, the CH effect remains positive. The coefficient on CH is significant in all specifications except when the risk adjustment is based on the Carhart four-factor model. I also confirmed the pronounced negative momentum effect for January months reported by Chou, Ho, and Ko (2012). This effect actually weakens the significance of the positive momentum effect in the full sample (see Table 2). I also investigated whether the negative CCH effect observed for January months in standard and risk-adjusted FamaMacBeth regressions (Table A1) is confirmed in the portfolio analysis. Table A2 reports the alphas of the CCH portfolios for January months only. Consistent with

Table A1.  FamaMacBeth Cross-Sectional Regressions for January Returns, July 1965December 2010 (t-statistics in parentheses)
Model 1 2 INT 15.23 (5.71) 14.95 (6.03) B. Dependent variable = FF3RA 3 4 9.32 (4.33) 9.08 (4.11) C. Dependent variable = FF4RA 5 6 9.42 (3.71) 8.99 (3.72) *Significant at the 10% level. **Significant at the 5% level. ***Significant at the 1% level. 3.85** (2.43) 1.90 (1.52) 0.72*** (3.37) 0.70*** (3.42) 0.31 (1.15) 0.28 (1.09) 1.92*** (3.37) 1.90*** (3.34) 1.17*** (3.03) 0.88*** (2.90) 1.03** (2.37) 1.21** (2.08) 0.01 (0.07) 0.05 (0.26) 3.22* (1.79) 1.74** (2.17) 0.70*** (4.32) 0.70*** (4.14) 0.27 (0.89) 0.20 (0.75) 2.56*** (4.17) 2.52*** (3.96) 1.52*** (3.91) 1.09*** (3.58) 1.14** (2.20) 1.25** (2.01) 0.03 (0.12) 0.01 (0.03) CCH 3.22** (2.13) 2.48** (2.01) CH ME 1.06*** (5.13) 1.06*** (5.46) BM 0.48 (0.95) 0.59 (1.34) MOM 2.67*** (4.36) 2.28*** (4.33) AG 1.27*** (4.27) 0.96*** (3.70) Illiq 1.07*** (5.71) 1.21** (2.00) IVolm 0.59*** (4.06) 0.55*** (3.64) A. Dependent variable = ER

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Table A2.  Alphas of Portfolios Sorted on Changes in Cash Holdings for January Returns, July 1965December 2010 (t-statistics in parentheses)
Sample A. Ranking on CCH All January months -FF3 -FF4 2.04 (4.90) 1.96 (4.77) Subsamples Low IVol -FF3 -FF4 High IVol -FF3 -FF4 0.00 (0.00) 0.06 (0.25) 4.11 (5.10) 4.04 (4.90) Differences High IVol Low IVol High IVol Low IVol -FF3 1.28 (4.96) 1.22 (4.96) 0.12 (0.37) 0.16 (0.53) 3.88 (4.74) 3.82 (4.54) 0.66 (1.77) 0.61 (1.83) 0.25 (0.78) 0.29 (0.96) 3.46 (4.94) 3.36 (4.77) 1.04 (3.83) 1.02 (3.89) 0.20 (0.79) 0.20 (0.76) 3.83 (4.77) 3.77 (4.70) 1.38 (5.20) 1.34 (5.02) 0.05 (0.21) 0.04 (0.20) 3.10 (5.18) 3.02 (4.85) 0.66 (2.12) 0.62 (2.02) 0.05 (0.16) 0.02 (0.09) 1.01 (2.00) 1.01 (1.93) 0.96 (1.93) -FF4 1.03 (2.10) B. Ranking on CH All January months -FF3 -FF4 0.90 (2.79) 0.83 (3.12) Subsamples Low IVol -FF3 -FF4 High IVol -FF3 -FF4 0.23 (0.64) 0.28 (0.85) 3.58 (5.06) 3.50 (4.93) Differences High IVol Low IVol High IVol Low IVol -FF3 0.96 (3.09) 0.92 (3.22) 0.40 (1.00) 0.43 (1.08) 3.74 (4.82) 3.65 (4.61) 1.00 (4.26) 0.97 (4.50) 0.12 (0.44) 0.15 (0.57) 3.58 (4.38) 3.49 (4.14) 1.60 (3.02) 1.52 (2.71) 0.11 (0.84) 0.12 (0.92) 3.84 (4.34) 3.70 (3.94) 3.08 (5.33) 3.01 (5.02) 0.39 (1.33) 0.37 (1.28) 4.53 (6.04) 4.50 (5.90) 2.17 (3.04) 2.18 (3.06) 0.62 (1.47) 0.65 (1.56) 0.95 (1.92) 1.00 (2.08) 0.33 (0.60) -FF4 0.35 (0.64) IVol Alpha 1 2 3 4 5 51

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the results regressions, 51 spread nificant FF3

of FamaMacBeth cross-sectional the difference portfolio (i.e., the portfolio) shows negative and sigand FF4 alphas (0.66% and 0.62%,

respectively) for January months. Thus, the portfolio analysis confirms that there is a CCH effect for January months, which is at odds with the rational explanation.

Notes
1. See, for example, Opler, Pinkowitz, Stulz, and Williamson (1999); Dittmar and Mahrt-Smith (2007); Bates, Kahle, and Stulz (2009). 2. Consistent with Palazzo (2012), I found no unconditional relation between CH and future stock returns but observed a strong CH effect when conditioning on size and book-to-market. 3. Investors may be too slow to incorporate information regarding changes in a companys cash holdings into its stock prices (for a similar argument on company investment, see Titman, Wei, and Xie 2004; Cooper, Gulen, and Schill 2008). Recently, many papers have stressed the importance of limits to arbitrage (i.e., mispricing) in explaining investment, asset growth, and accrual anomalies (see, e.g., Li and Zhang 2010; Li and Sullivan 2011). 4. As stated in Li and Sullivan (2011, p. 51), When confronted with holding a position with high IVol, investors are less willing to engage in arbitrage because such a position is costly to hedge. Note that other studies have also used idiosyncratic stock return volatility to measure arbitrage risk (see, e.g., Pontiff 1996; Mashruwala, Rajgopal, and Shevlin 2006). 5. http://mba.tuck.dartmouth.edu/pages/faculty/ken. french/. 6. Note that IVolm is a monthly idiosyncratic volatility and a stock return predictor estimated as in Ang, Hodrick, Xing, and Zhang (2006), whereas IVol is a 12-month (JulyJune) idiosyncratic volatility that is used to split the sample into low- and high-IVol groups (see, e.g., Li and Sullivan 2011). 7. For non-January months, these alphas are 41% and 31% (for high-IVol stocks) and 25% and 19% (for low-IVol stocks), respectively.

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