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The optimal liquidity principle with restricted borrowing

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  • Mierzejewski, Fernando

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.

Suggested Citation

  • Mierzejewski, Fernando, 2008. "The optimal liquidity principle with restricted borrowing," MPRA Paper 12549, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:12549
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    References listed on IDEAS

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    More about this item

    Keywords

    Liquidity-preference; Money demand; Monetary equilibrium; Market price of risk; Sharpe ratio;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • 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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