Abstract
Whether there is a cash anomaly and what drives the cash–returns relationship are unclear. By constructing a cash risk factor, this study explores the cash–returns relationship and the mechanisms underlying it. We find that the cash factor is pervasive and captures co-movement in stock returns, indicating a significant cash–returns relationship. The factor loading cannot predict returns after controlling for the cash characteristic and has a negative relationship with the implied cost of capital. Also, the cash factor does not reflect future macroeconomic risk. These results are not consistent with rational capital asset pricing theories and cast doubts on the role of the risk explanation while supporting the role of the mispricing effect in the cash–returns relationship.
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