ON THE CORRESPONDENCE BETWEEN THE BAUMOL‐TOBIN AND MILLER‐ORR OPTIMAL CASH BALANCE MODELS

Abstract

ABSTRACTIn this note, the author identifies a correspondence relationship between the Baumol‐Tobin (BT) and Miller‐Orr (MO) optimal cash balance frameworks and specifies the conditions under which both models imply the same level of optimal cash balances. Realistic applications of these models will concern net cash flows that exhibit behavior somewhere between the two extremes of BT entirely deterministic and MO completely random. The author demonstrates that if the correspondence relationship is satisfied, either the BT or the MO cash balance model can be employed since both models imply the same result. One conjecture open for empirical verification is that cash balance models perform more (less) adequately for groups of firms that satisfy (violate) the correspondence relationship.