Is Cash-Return Relation Risk Induced?

Palazzo [2012] finds a positive relation between cash holdings and stock return and attributes this to the association between cash and systematic risk with respect to growth options. In this paper, I try to test whether the relation between cash and return is driven by systematic risk that captured by cash. The empirical results do not support the risk explanation of cash-return relation. First, the loadings on CASH factor cannot predict returns, which is not consistent with rational frictionless asset pricing models. Second, CASH factor cannot reflect future GDP growth. Third, CASH and its factor loadings exhibit no association with implied cost of capital derived from analysts’ earnings forecasts. Overall, this paper casts doubt on the argument that cash can serve as a proxy of systematic risk in the explanation of cross sectional variation in stock returns.