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Financial Flow Variables and the Short-Run Determination of Long-Term Interest Rates

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  • Friedman, Benjamin Morton
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    Abstract

    Because transactions costs are smaller for allocating new cash flows than for reallocating existing asset holdings, financial flow variables are important determinants of investors' short-run asset demands. The demand-for-bonds equations implied by the resulting "optimal marginal adjustment" model of portfolio behavior constitute the demand side of a structural supply-demand model of the determination of the long-term interest rate. Empirical results, based on demand-for-bonds equations estimated using U.S. data for six major categories of bond market investors, support the optimal marginal adjustment model and show that the associated structural model of interest rate determination, which is restricted by the underlying demand-for-bonds equations, fits the data about as well as do previously developed unrestricted reduced-form term-structure equations.

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    File URL: http://dash.harvard.edu/bitstream/handle/1/4554309/Friendman_FinancialFlowV.pdf
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    Bibliographic Info

    Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 4554309.

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    Date of creation: 1977
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    Publication status: Published in Journal of Political Economy -Chicago-
    Handle: RePEc:hrv:faseco:4554309

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    1. Modigliani, Franco & Shiller, Robert J, 1973. "Inflation, Rational Expectations and the Term Structure of Interest Rates," Economica, London School of Economics and Political Science, London School of Economics and Political Science, vol. 40(157), pages 12-43, February.
    2. Ladenson, Mark L, 1971. "Pitfalls in Financial Model Building: Some Extensions," American Economic Review, American Economic Association, American Economic Association, vol. 61(1), pages 179-86, March.
    3. Brundy, James M & Jorgenson, Dale W, 1971. "Efficient Estimation of Simultaneous Equations by Instrumental Variables," The Review of Economics and Statistics, MIT Press, vol. 53(3), pages 207-24, August.
    4. Friedman, Benjamin M, 1971. "Econometric Simulation Difficulties: An Illustration," The Review of Economics and Statistics, MIT Press, vol. 53(4), pages 381-84, November.
    5. William C. Brainard & James Tobin, 1968. "Pitfalls in Financial Model-Building," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 244, Cowles Foundation for Research in Economics, Yale University.
    6. Reuben A. Kessel, 1971. "The Cyclical Behavior of the Term Structure of Interest Rates," NBER Chapters, in: Essays on Interest Rates, Vol. 2, pages 337-390 National Bureau of Economic Research, Inc.
    7. Feldstein, Martin S & Eckstein, Otto, 1970. "The Fundamental Determinants of the Interest Rate," The Review of Economics and Statistics, MIT Press, vol. 52(4), pages 363-75, November.
    8. James M. Brundy & Dale W. Jorgenson, 1971. "Efficient estimation of simultaneous equations by instrumental variables," Working Papers in Applied Economic Theory, Federal Reserve Bank of San Francisco 3, Federal Reserve Bank of San Francisco.
    9. Feldstein, Martin S & Chamberlain, Gary, 1973. "Multimarket Expectations and the Rate of Interest," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 5(4), pages 873-902, November.
    10. Fair, Ray C & Malkiel, Burton G, 1971. "The Determination of Yield Differentials between Debt Instruments of the Same Maturity," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 3(4), pages 733-49, November.
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