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A Theory of Liquidity and Risk Management Based on the Inalienability of Risky Human Capital (joint with Patrick Bolton and Jinqiang Yang)

Monday, November 17, 2014
4:00 PM - 5:00 PM
Location: Baxter B125
Neng Wang, Chong Khoon Lin Professor of Real Estate and Finance, Columbia Business School

We analyze a dynamic optimal financial contracting problem in continuous time with risky cash flows between a risk-averse entrepreneur and risk-neutral investors.  Two fundamental constraints on the contracting parties are that: 1) the entrepreneur cannot alienate his human capital, and 2) investors have limited liability protection.  Given that human capital is risky, the entrepreneur's inability to commit his human capital to the firm generates significant distortions for corporate investment and consumption risk-sharing. We show that the optimal contracting problem boils down to a corporate liquidity and risk-management problem (implementable via futures and insurance contracts) for the firm. Our analysis thus provides new foundations for liquidity and risk management policies that firms routinely pursue in practice.

Finance Seminars at Caltech are funded through the generous support of the Linde Institute and Stephen A. Ross.

Series: Finance Seminar Series
For more information, please phone Ext. 4228

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