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Bernak Model

# Bernak Model

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07/04/2012

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Beranek’s Model
( )
ω
A A
=
the cash out flow depends on the uncertain event
ω
which makes
( )
ω
A
a stochasticvariable.
( ) ( )
ω ω
A
=
001
,Beranek assumes there is a critical cash balance
*
which triggers increased cost borrowing
+
. In t=0 we have cash of
0
in t=1
ω
is observed and
( )
ω
A
is paid from
0
(possiblyunder acceptance of penalty interest
). Keep in mind, that
0
here denotes the cash level thatwe initially establish in t=0 with only one cash outflow
( )
ω
A
occurring. Where as in Baumol’smodel
0
denotes the amount that is withdrawn m times.The return of the policy
0
is as follows:
( ) ( )( ) ( )
( )
<+ =
otherwise for   K h
0,,~
*101*00
ω ω
( )( ) ( ) ( )
( )
++ =
otherwise A for  A  K
0
*00*0
ω ω
Objective function:
( )( )
ω
,
0
max
0
h E
( )( ) ( )
( )
( ) ( )
++=
∫
*0
0*00
,
ω
with
( )
A F
as the distribution function of
( )
ω
A
( )( )
( )
( )
++=
∫
*0
0*00
To evaluate the expression above we use Leibnitz:
( )
( )( )( )( )
( )( )( )( )( )( )( )
functionsabledifferenticontinous g anvuwith u g uv g vdx x g dx x g
vuvuda
,,,,,
α  α  α  α  α  α  α  α  α  α  α
α  α  α  α
+=
∫
( ) ( ) ( )
( )
+++=
∫
*0
*00*
101
( )( )
( )( )
011
*0
=+=
F
( )
*0
1
F
=+
( )
*0
11
F
=+=+
then
*01
11
F
=      +
or
*01
11
F
=      +
      ++=
F
11
1**0

That means the optimal level of cash is the critical level
*
plus a risk mark up
      +
F  RM
11
1
0
<
RM
0
>
RM
0
*0
<
0
*0
>
RM
How does a distribution function that tends to result in higher
( )
ω
A
affect
RM
.
( )
( )
( )
( )
( ) ( )
0000
11
00
A A prob A A prob A A prob A A prob
G F  AGG A F  F
( ) ( )
00
A A prob A A prob
G F
The probability to pay out A
0
with G is at least as high as with F.Intuitively we say, with G we hold at least as much cash as F.This means G is stochastic dominant to F:
( ) ( )
G F G A A F  AG
11
has greater RM and
*,0*,0
G
Critique:model static (to change that see Miller Model next week)model does not reflect economic realities here in Germany(in Germany businesses usually negotiate a line of credit (LC) where the bank charges a commitment fee independent of the actual usage of the LC, only after the LC is exhausted the cost of borrowing increase.)Model extension:-
0
remains in a interest bearing account (i.e. money market account) that earns interest
M
--
0
K
is invested in a CD (i.e. time account) interest
CD
-a LC in the volume of L is available interest
LC
-if we exceed L the cost of borrowing increase to
δ
+
LC
-commitment fee in % for the LC is
CF
The return of the policy
0
is as follows:
( ) ( )( )
++ +=
L for  L  L for   for   Lr  K  Lh
LC  LC  M CF CD
111111100
00,
δ
Objective function:
( )( )
max
,0
0
,
L
Lh E O
=
With:
( )( ) ( ) ( ) ( ) ( ) ( )( ( ) ( ) ) ( )
L LC  L LC  M CF CD
∫ ∫ ∫
++
+++ ++=
0000
0000000
,
δ
first order condition: