Demand For Financial Assets Research Articles

Expanding the use of the ruble in international settlements

The freezing of Russian assets and the continued risk of new sanctions creates incentives for abandoning the currencies of unfriendly countries and expanding the use of the ruble in cross-border settlements. In addition to prestige, the advantage of the internationalization of the national currency is the reduction of transaction costs and foreign exchange risks of foreign trade participants, which will contribute to the development of foreign trade. An increase in external demand for financial assets denominated in rubles will help increase the depth of the market and reduce the cost of borrowing. The need for additional international reserves will decrease, the storage of which may be associated with the costs of depreciating the reserve currency, obtaining negative real returns on assets denominated in reserve currencies, as well as with sanctions risks.

Modeling Monopoly Money: Government as the Source of the Price Level and Unemployment

Many of the claims put forth by Modern Monetary Theory (MMT) center around the state’s monopoly over its own currency. In this paper I interrogate the plausibility of two claims: 1) MMT’s theory of the price level—that the price level is a function of prices paid by government when it spends—and 2) the claim that the cause of deficient effective demand is the state’s failure to supply government liabilities so as to meet the demand for net financial assets. I do so by building a model of “monopoly money” capable of producing these two outcomes.

Risk, ambiguity, and Giffen assets

We provide necessary and sufficient conditions for the demand for financial assets to satisfy the law of demand (prices and quantity demanded move in opposite directions) when preferences take the expected utility, multiplier preferences, Choquet expected utility, and the maxmin expected utility forms. For the first three models the law of demand holds when the variation in the coefficient of relative risk aversion stays within a specified bound. Ensuring the law of demand holds in the maxmin expected utility model requires constant relative risk aversion.

A Dealer Illiquidity Risk Premium in the Money Markets

Safe and liquid assets like Treasuries are not a cash substitute. However, dealer banks may transform Treasuries into a money-like financial asset, i.e., a repurchase agreement collateralized with Treasuries. The ratio of Treasuries useable as repo collateral by dealer banks over demand for money-like financial assets by institutional investors is a statistically and economically significant determinant of spreads in both money and bond markets beyond conventional determinants. The ratio captures a risk premium for the illiquidity of the dealer system that is due to the time-varying market liquidity of repo collateral.

Economic Slowdown and Housing Dynamics in China: A Tale of Two Investments by Firms

In the past decade, the Chinese economy has witnessed a great housing boom, accompanied by a slowdown in economic growth and an increase in firms' financial investment. The waning economic prospects lead to a surge in housing prices by stimulating firms' demand for financial (especially housing) assets. Motivated by these facts, we take an off-the-shelf dynamic New Keynesian model with novel modeling of firms' dynamic portfolio choice between physical and housing investment. Housing assets earn a positive return and can be used as collateral for the firm's external finances. A negative productivity shock decreases the relative return of production capital, which translates into a housing boom by increasing the firm's housing demand. A rise in house prices then generates competing effects on real investment: it not only raises the firm's leverage due to the collateral effect but also depresses the firm's demand for physical capital because of the crowding-out effect. After calibrating the model for the Chinese economy, our quantitative exercise suggests the former effect is dominated by the latter, which implies counter-cyclical housing prices. Among the policies used to stabilize the aggregate economy and housing markets, our counterfactual analysis implies that the capital subsidization policy targeting house prices performs better than other macroeconomic policies.

Analysis of Households’ Investment Decisions Based on International Data

The paper attempts to pinpoint the economic, demographic and risk-taking factors that influence households’ demand for risky financial assets, using the Household Finance and Consumption Survey (HFCS) database as the basis for the analysis. From the perspective of risky asset holding, supply is also important, and therefore clustering was used to identify several country groups based on capital market features. The study mainly focuses on the countries that are, similar to Hungary, less active based on their capital market features, but the characteristics of countries with a more active capital market are also presented for comparison. In line with the empirical literature, demand for risky assets is examined using econometric tools, isolating the effect of the significant factors. Accordingly, separate logit models were created for the demand factors in the different country groups under review, i.e. those with a less mature and those with a highly mature capital market. The results indicate that income, wealth, skills and risk-taking positively influence risky asset holding, while liquidity constraints and background risks have a negative influence; the findings confirm the preliminary expectations and can be deemed robust.

Maximum probabilities, information, and choice under uncertainty

This note proposes a simple, expected utility-like model for decision making under uncertainty. The model uses the maximum probability for each possible outcome and the amount of information conveyed by this upper envelope. A graphical tool is introduced and used to study the model when two outcomes are possible. The model is extended to an abstract number of outcomes in which interpersonal comparisons of preferences are considered along with applications to medical decision making and financial asset demand.

Momentum Effect, Value Effect, Risk Premium and Predictability of Stock Returns - A Study on Indian Market

Efficient market hypothesis (EMH), one of the central pillars of modern financial theories, often fails to explain the ?financial anomalies?. One fatal challenge of EMH probably comes from the theoretical assumption of ?rational man?. According to EMH, the fully rational investor may change his demand for financial assets on the basis of available information. According to EMH, at any given point of time, the stock price should reflect all the available information, and predictability of stock returns should be impossible. However, the literature shows ample evidence of abnormal returns related to firm and market specific attributes. In financial literature, these variations are often termed as ?financial anomalies?. Within the framework of behavioural finance, there are research results that contain evidence on predictability of future stock market returns based on financial anomalies (Stanivuk et al., 2012). Value effect and momentum effect are the two prominent financial anomalies (Ho, 2012). This paper explores the predictability of Indian stock market returns using multiple discriminant analysis. Our result shows that the risk premium, momentum and value effect may have significant power for predicting the Indian stock market returns. The validity test of the model also corroborates the impact of financial anomalies over predictability of stock returns.

What Are Asset Demand Tests of Expected Utility Really Testing?*

Assuming the classic contingent claim setting, a number of financial asset demand tests of Expected Utility have been developed and implemented in experimental settings. However the domain of preferences of these asset demand tests differ from the mixture space of distributions assumed in the traditional binary lottery laboratory tests of von Neumann-Morgenstern Expected Utility preferences. We derive new sets axioms that are necessary and sufficient for preferences over contingent claims to be representable by an Expected Utility function. We also indicate the additional axioms required to extend the representation to the more general case of preferences over risky prospects.

Methodology to Estimate the Financial Market Condition

The article systematizes theoretical approaches to the definition of product in the financial market. The system of monitoring market processes associated with shaping demand for financial assets was proposed to implement in order to monitor current trends that form the demand on the financial market and to timely detect structural imbalances. The results of the studies have shown the presence of critical foreign exchange imbalances in shaping demand on the financial market, which is due to the excessive level of its foreign currency predominance and is a testament to both the insufficient level of confidence in the national currency and the predominance of speculative motivations at the conclusion of the agreements. The formalization of the relationship between the demand for financial assets and the level of economic growth of the country has allowed to substantiate the need for the transformation of the conceptual bases of its regulation in the transition away from the traditional approach to structural regulation.

On Collateral: Implications for Financial Stability and Monetary Policy

This paper examines the role of collateral in the financial system, with special emphasis on the implications for financial stability and the conduct of monetary policy. First, we review what drives the demand and supply for both real and financial collateral assets. Then we examine financial stability issues and the case for regulating the use of collateral. We discuss the role and design of market infrastructures such as central clearing counterparties (CCPs). Finally, we examine the interaction of standard and non-standard monetary policy and the functioning of private collateralised markets. We show that the use of collateral is neither a sufficient nor a necessary condition for financial stability. To ensure the stability of collateralised markets a mix of micro- and macro-prudential regulation, as well as a sufficient supply of safe public assets that can be used as collateral, are needed.

Arbitrage with Production, Collateral Constraint and Heterogeneous Belief

We construct a dynamic model economy in which households from segmented markets have varying financial asset demands. Intermediaries make arbitrage profit by exploiting the price difference in segmented financial markets. Meanwhile, they are required to separately post their production investment as collateral to support liquidity supply. We show that without uncertainty the intermediaries exhibit self-recovery capacity after negative shocks. We also demonstrate that with uncertainty and agents' inaccurate estimation of future market demand, looser collateral constraints can disturb such self-recovery process and further incur systemic risk through over investment in financial markets and under investment in production. On the contrary, tighter collateral constraints can stabilise the economy and boost the production sector at the cost of market liquidity. The dynamic interaction between the endogenous collateral constraint and liquidity supply turns out to be a powerful transmission mechanism by which the effects of disturbance persist, amplify and spill over to other sectors.

Demand for financial assets and monetary policy: a restatement of the liquidity preference theory and the speculative demand for money

:Keynes implicitly used the concept of duration to analyze the impacts of expected changes in the price of a perpetual bond and coupon payments that led to his “square rule.” Keynes’s result (“square rule”), derived from the breakeven condition, was just a simplification to illustrate the importance of expected interest changes on the total return of an investor’s portfolio, constrained to money and consols. Keynes’s world is not one of yield, but one of total return, where price and yield form the returns. This paper aims to show that the same breakeven method can be used, but instead of a simple two-asset model (money and a specific financial asset such as consols) this framework can be generalized to take into account a broad spectrum of financial assets including perpetuals, zero-coupon, coupon bearing securities for different maturities and investment horizons, and risk preferences to analyze the impacts of expected changes in interest rates on total expected return. By using Keynes’s breakeven condition and total return analysis, it is possible to generalize this argument for different types of securities (and not just consols) and it follows the approach of chapter 17 of the General Theory. In this paper, I update and extend Keynes’s analysis to allow for different holding periods (or investment horizons) and different financial instruments. When we take into account duration and convexity effects, and given rising expected changes in interest rate, we get an upward sloping demand for securities with short duration relative to investment horizon rather than a downward sloping speculative money demand schedule. In this framework, duration and breakeven analysis play a crucial role in the demand for financial assets as bank’s expectation on rate changes will generate a demand for short (or long) duration financial assets impacting asset prices.

International Liquidity and Exchange Rate Dynamics *

Abstract We provide a theory of the determination of exchange rates based on capital flows in imperfect financial markets. Capital flows drive exchange rates by altering the balance sheets of financiers that bear the risks resulting from international imbalances in the demand for financial assets. Such alterations to their balance sheets cause financiers to change their required compensation for holding currency risk, thus affecting both the level and volatility of exchange rates. Our theory of exchange rate determination in imperfect financial markets not only helps rationalize the empirical disconnect between exchange rates and traditional macroeconomic fundamentals, it also has real consequences for output and risk sharing. Exchange rates are sensitive to imbalances in financial markets and seldom perform the shock absorption role that is central to traditional theoretical macroeconomic analysis. Our framework is flexible; it accommodates a number of important modeling features within an imperfect financial market model, such as nontradables, production, money, sticky prices or wages, various forms of international pricing-to-market, and unemployment.

Do demographic changes matter? A cross-country perspective

We explore the inflation-adjusted yields on benchmark 10-year government bonds in seven developed countries to see if both demographic and non-demographic variables can explain why real bond yields are so low.We find that over the last 60 years there has been a regime shift in the late-1980s that radically altered output growth in major economies as dependency ratios declined. Because of this change we used two time periods for our models: low-frequency annual data from 1950 to 2012 and quarterly data from 1990 to 2013. We show that population age ratios are important as a determinant in the demand for financial assets. In this paper we also introduce a global proxy for quantitative easing (QE). We find that in developed markets in Europe and North America the QE has lowered bond yields by approximately 50–100bps since the global credit crisis began.

Spillover and Amplification with Financially Constrained Intermediaries

We construct a dynamic model economy in which investors from segmented markets have varying financial asset demands. Intermediaries make arbitrage profits by exploiting the price spreads across markets. Meanwhile, they are required to separately post collateral to support arbitrage trades. We show that with volatile asset demands, arbitrage becomes risky. With information frictions, a looser collateral policy might render the economy more vulnerable to extremely large demand shocks, while a tighter collateral constraint helps maintain the stability at the cost of market liquidity supply.

Shadow Banking and Traditional Bank Lending: The Role of Implicit Guarantees

Bank holding companies invest in risky projects through regulated bank entities and sell projects for a fee, thus engaging in shadow banking. To increase the fee income, BHCs guarantee sold projects with bank proceeds. When demand for financial assets is high, BHCs expand their own bank investments to increase the value of guarantees and to boost the income from off-balance intermediation. The banking sector and the shadow banking sector both expand, bank defaults are more frequent, and guarantees effectively provide recourse to government guarantees enjoyed by regulated banks. By adjusting the minimum capital requirement for banks the regulator can eliminate some of the negative effects of the guarantees.

THE RELATIONSHIP BETWEEN RELATIVE RISK AVERSION AND THE LEVEL OF EDUCATION: A SURVEY AND IMPLICATIONS FOR THE DEMAND FOR LIFE INSURANCE

AbstractThe expected utility hypothesis has been widely used in the construction of economic models and numerous difficulties are encountered in attempting to take into account preferences toward risk in a real‐world setting. More recently, attention has focused on comparative studies in economics and business in an international framework and problems related to the hypothesis of relative risk aversion (RRA). One ambiguous hypothesis is the relationship between the level of RRA and the level of education, which has been found either positive or negative. From a causality point of view, it may be argued that investors with a high level of education are less risk averse, but it may also be argued that less risk‐averse individuals choose to pursue a higher level of education. The purpose of this paper is to survey the empirical literature on this subject. It provides evidence that risk aversion is negatively correlated with higher education and human development. The results have important implications for macroeconomic empirical studies and the demand for financial assets and more specifically on the demand for life insurance. Assuming the same degree of RRA for utility‐maximizing consumers should be limited to homogeneous samples.

International Liquidity and Exchange Rate Dynamics

We provide a theory of the determination of exchange rates based on capital flows in imperfect financial markets. Capital flows drive exchange rates by altering the balance sheets of financiers that bear the risks resulting from international imbalances in the demand for financial assets. Such alterations to their balance sheets cause financiers to change their required compensation for holding currency risk, thus impacting both the level and volatility of exchange rates. Our theory of exchange rate determination in imperfect financial markets not only rationalizes the empirical disconnect between exchange rates and traditional macroeconomic fundamentals, but also has real consequences for output and risk sharing. Exchange rates are sensitive to imbalances in financial markets and seldom perform the shock absorption role that is central to traditional theoretical macroeconomic analysis. We derive conditions under which heterodox government financial policies, such as currency interventions and taxation of capital flows, can be welfare improving. Our framework is flexible; it accommodates a number of important modeling features within an imperfect financial market model, such as non-tradables, production, money, sticky prices or wages, various forms of international pricing-to-market, and unemployment.

Financial innovation and regional money

This article studies the effect that financial innovation, which has been very common in recent years, has on money. Using Japanese regional data and the money demand specification, we first provide evidence of instability in the simple money-output relationship. However, when this relationship is extended to include a proxy for a comprehensive measure of financial innovation, the model is found to be stable. Furthermore, consistent with economic theory, evidence is obtained of financial innovation leading to decreased demand for liquid financial assets. In this respect, in Japan demand deposits seem to possess very similar characteristics to cash over recent years.