DEMAND FOR GOVERNMENT SECURITIES

THIS STUDY CONSTRUCTS a conceptual framework for analyzing commercial-bank, nonbank-financial, corporate, and household demand for government securities and presents empirical estimates of the model developed. The theoretical foundation of this study relies heavily on the theory of portfolio selection developed by Markowitz, Tobin, and Farrar, which for all practical purposes may be labeled the "modern theory of portfolio selection." However, this modern theory of portfolio selection is essentially a static model which does not explain portfolio adjustments through time. One of the objectives of this study is to recast the model in terms of stock-flow analysis such that changes of asset holdings occurring over time could be viewed as planned adjustments in portfolio stocks designed to remove discrepancies between equilibrium (or desired) and actual stocks. The fundamental assumptions of stock-flow analysis are that changes in an investor's stock holdings depend on the discrepancy between desired and actual stocks and that these changes are zero if and only if desired stocks equal the actual stocks. The model of this study embodies a version of the stock-adjustment model in which financial as well as nonfinancial variables serve as the determinants of the demand for government securities by each sector. According to our general model, which employs a wealth constraint, the desired amount (in nominal terms) of government securities in each sector's portfolio is assumed to be determined by a vector of the expected returns on all assets in the portfolio, a vector of indices of risk on all assets in the portfolio, and the total wealth to be invested. The assumption of homogeneity of degree one in wealth is made in the formulation of the desired-stock function. Then, in order to account for dynamic portfolio adjustments, the model is recast in terms of stock-flow analysis. In so doing, we propose that purchases or sales of government securities stem from two considerations: the desired-adjustment component and a short-run component where the desired changes are assumed to be made by the investor to fill the gap between the desired stock and the old stock remaining from the preceding period. The purpose of introducing the second component is to capture the short-run or unplanned adjustments in the stock of government securities undertaken in response to changes in variables of a short-run or unexpected nature. Data used in this study are unpublished figures compiled by the staff of the Board of Governors of the Federal Reserve System. Security holdings (all marketable) are disaggregated into two maturity classes. Securities maturing in five years or less are classified in the short-term categories, and those with maturity greater than five years are classified in the long-term category. Preliminary estimations with various alternative categorization of maturities indicated that it makes little difference whether the short-term category consists of maturities of one year or less or maturities of five years or less. The data used are quarterly time series extending from the first quarter of 1953 through the fourth quarter of 1966.