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Safety-First and Portfolio Selection: An Econometric Study for Pakistan's Banking Sector

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  • J L Ford
  • Zahid Muhammad

Abstract

A.D. Roy's original formulation of the Safety-First Principle is used to derive models of the portfolio composition of the banking sector in Pakistan. To estimate the models we use data for 1964-2005 and for 2005-2008 for forecasting. Various models are estimated, wherein loads are segrated into their various classes, with and without restrictions implied by the theory, such as symmetry on asset characteristics and the equivalent of Engel conditions. The best specification of the system of asset demand equations is a dynamic version which allows for adjustment costs or adjustment constraints in the alignment of the portfolio. It is also demonstrated that a model that diaggregates the various types of bank loans dominates one wherein they are treated as perfect substitutes. The superior model provides information on the complements and the substitutes amongst the assets that conforms to economic intuition. That model also fits the data well.

Suggested Citation

  • J L Ford & Zahid Muhammad, 2010. "Safety-First and Portfolio Selection: An Econometric Study for Pakistan's Banking Sector," Discussion Papers 10-18, Department of Economics, University of Birmingham.
    • Handle: RePEc:bir:birmec:10-18
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    References listed on IDEAS

    as
    1. Iimi, Atsushi, 2004. "Banking sector reforms in Pakistan: economies of scale and scope, and cost complementarities," Journal of Asian Economics, Elsevier, vol. 15(3), pages 507-528, June.
    2. Lester G. Telser, 1955. "Safety First and Hedging," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 23(1), pages 1-16.
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    More about this item

    Keywords

    Safety-First Principle; asset demand equations; symmetry; homogeneity; adding-up constraints; dynamic adjustment; disaggregation versus aggregation of loans;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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