A Rationalization Of The Precautionary Demand For Cash

I. The main ideas
1. Application of the principles of inventory theory to the transactions demand for cash and use of the strategy of portfolio selection to examine the demand to hold money as an asset have represented significant responses to Hicks's suggestion that the theory of rational choice should be incorporated into the demand for money .

2. This article attempt to apply the logic of rational behavior to another of the Keynesian triad of motives for holding cash: the precautionary demand for cash. And comparing it with these interpretations

3. Try to finding what extent the approach developed above deviates from the variously interpreted precautionary demand for cash.

4. Concept bases: Three factors affect the optimal size of precautionary cash balances: (1) the cost of illiquidity; (2) the opportunity cost of holding precautionary cash balances; and (3) the average volume and variability of receipts and disbursements.
Since cash earns no explicit return, a firm incurs an opportunity cost when it holds cash instead of alternative income-earning assets.
The variability and average volume of receipts and disbursements also infiuences the size of precautionary cash balances.

II. Methodology


The total cost of precautionary cash management is equal to the sum of the opportunity cost of holding cash and the expected cost of illiquidity
M*r
(M : average precautionarycash balances, and r: the opportunity cost rate)

The expected cost of illiquidity, on the average, is equal to the cost of failing to provide adequate cash funds to meet required disbursements times the probability of this type of financial embarrassment occurring.
P*c
(p :the probability that net disbursements will be ...
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