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The optimal liquidity principle with restricted borrowing

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Mierzejewski, Fernando

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Abstract

A model is presented to characterise the (optimal) demand for cash balances in deregulated markets. After the model of James Tobin, 1958, net balances are determined in order to maximise the expected return of a certain portfolio combining risk and capital. Unlike the model of Tobin, however, the price of the underlying exposures are established in actuarial terms. Within this setting, the monetary equilibrium determines the rate at which a unit of capital is exchange by a unit of exposure to risk, or equivalently, it determines the market price of risk. In a Gaussian setting, such a price is expressed as a mean-to-volatility ratio and can then be regarded as an alternative measure to the Sharpe ratio. The effects of credit and monetary flows on money and security markets can be precisely described on these grounds. An alternative framework for the analysis of monetary policy is thus provided.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 12549.

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Date of creation: 30 Dec 2008
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Handle: RePEc:pra:mprapa:12549

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Related research
Keywords: Liquidity-preference; Money demand; Monetary equilibrium; Market price of risk; Sharpe ratio;

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money

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