Monetary policy and financial investments of nonfinancial firms: New evidence from China

Abstract

This paper develops a portfolio choice model by incorporating monetary policy and analyzes the determinants of financial investments of nonfinancial firms in China. Unlike the literature assuming financial investments are riskless, we allow risks in both financial and real investments in firms' portfolio choice model. Our theoretical framework suggests that monetary policy, relative risk in fixed investment, and the risk-adjusted return gap between financial and fixed investments are determinants of firms' financial investments. Using firm-level panel data over the period from 2006 to 2016, we find that the relative risk in fixed investment and quantitative expansionary monetary policy have led to rising financial investments of nonfinancial firms in China over the post-2008 financial crisis period, whereas the rate of the risk-adjusted return gap between financial and fixed investments plays no role in firms' financial investments. The impact of monetary policy on firms' financial investments is also interlinked with their ownerships, with distinct impacts emerging between state-owned and non-state-owned firms.