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Time-Dependent Portfolio Adjustment: Yet Another Look at the Dynamics


  • Pablo A. Guerron

    () (Department of Economics, North Carolina State University)


The interest semi-elasticity of money demand has been a long standing puzzle in the monetary economics literature. Researchers consistently have estimated low short-run semi-elasticities, usually around 1, and high long-run semi-elasticities of 10. Given the crucial role of interest semi-elasticity in determining the welfare costs of inflation and the effectiviness of tax cuts, we must understand why these short- and long-run estimates are so different. To explore this issue, I formulate and estimate a model of the demand for money that simultaneously accounts for low short- and high long-run semi-elasticities. In my formulation, re-balancing money holdings between money for purchases and money for financial investment is costly. I model this re-balancing cost by assuming that households re-optimize their money holdings subject to an exogenous probability. In the log-linearized version of my model, velocity depends on both its own past value and households' present and future expectations of the interest rate. I use this equilibrium condition to estimate my model's parameters by employing generalized method of moments. My estimates for the short-run and long-run interest semi-elasticities are 0.96 and 12.62, respectively. When I apply my model of money demand to explain the increase in the volatility of real balances after 1980, my model indicates that the late-1970s financial innovations, which facilitated portfolio re-balancing, lie behind this rise.

Suggested Citation

  • Pablo A. Guerron, 2006. "Time-Dependent Portfolio Adjustment: Yet Another Look at the Dynamics," Working Paper Series 006, North Carolina State University, Department of Economics, revised Aug 2006.
  • Handle: RePEc:ncs:wpaper:006

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    References listed on IDEAS

    1. Lazear, Edward P & Rosen, Sherwin, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 841-864, October.
    2. Green, Jerry R & Stokey, Nancy L, 1983. "A Comparison of Tournaments and Contracts," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 349-364, June.
    3. Theofanis Tsoulouhas & Charles Knoeber & Anup Agrawal, 2007. "Contests to become CEO: incentives, selection and handicaps," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 30(2), pages 195-221, February.
    4. Konrad, Kia A. & Kovenock, Dan, 2006. "Multi-Stage Contests with Stochastic Ability," Purdue University Economics Working Papers 1192, Purdue University, Department of Economics.
    5. Bhattacharya, Sudipto & Guasch, J Luis, 1988. "Heterogeneity, Tournaments, and Hierarchies," Journal of Political Economy, University of Chicago Press, vol. 96(4), pages 867-881, August.
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    More about this item


    Interest Semi-Elasticity of Money Demand; Time-Dependent Portfolio Adjustment; Volatility; GMM.;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications

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