Economic Policy Uncertainty and Corporate Cash Holding Decisions

Abstract

Economic policy uncertainty changes both the insurance value of corporate liquidity and the costs of retaining it. This study examines when uncertainty increases desired cash reserves, when competing mechanisms reverse that response, and why observed cash can depart from the desired buffer. A structured synthesis of corporate finance research is combined with a one-period liquidity model and transparent numerical scenarios. The model balances the opportunity and carrying costs of cash against expected losses from funding shortfalls, subject to an available-liquidity constraint. An increase in funding volatility raises optimal cash only under a stated condition; higher shortfall costs strengthen precautionary demand, while a greater internalized carrying burden reduces it. In the hypothetical baseline, optimal cash equals 8.11 units per 100 units of initial assets and rises to 10.57 when funding volatility increases. The same volatility increase, combined with a stronger carrying burden, instead produces 6.39 units. These calculations illustrate mechanisms rather than estimate policy effects. The analysis reconciles competing explanations without assuming a universal sign and establishes measurement and identification requirements for empirical research. Corporate cash policy should respond to firm-specific funding exposure, financing capacity, and governance rather than a mechanical policy-uncertainty threshold. Ultimately, this framework provides actionable insights for corporate managers and policymakers navigating volatile macroeconomic environments, ensuring robust financial stability and strategic resource allocation.