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Financial Flow Variables and the Short-Run Determination of Long-Term Interest Rates

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  • Friedman, Benjamin Morton

Abstract

Because transactions costs are smaller for allocating new cash flows than for reallocating existing asset holdings, financial flow variables are important determinants of investors' short-run asset demands. The demand-for-bonds equations implied by the resulting "optimal marginal adjustment" model of portfolio behavior constitute the demand side of a structural supply-demand model of the determination of the long-term interest rate. Empirical results, based on demand-for-bonds equations estimated using U.S. data for six major categories of bond market investors, support the optimal marginal adjustment model and show that the associated structural model of interest rate determination, which is restricted by the underlying demand-for-bonds equations, fits the data about as well as do previously developed unrestricted reduced-form term-structure equations.

Suggested Citation

  • Friedman, Benjamin Morton, 1977. "Financial Flow Variables and the Short-Run Determination of Long-Term Interest Rates," Scholarly Articles 4554309, Harvard University Department of Economics.
    • Handle: RePEc:hrv:faseco:4554309
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    References listed on IDEAS

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    1. Brundy, James M & Jorgenson, Dale W, 1971. "Efficient Estimation of Simultaneous Equations by Instrumental Variables," The Review of Economics and Statistics, MIT Press, vol. 53(3), pages 207-224, August.
    2. William C. Brainard & James Tobin, 1968. "Pitfalls in Financial Model-Building," Cowles Foundation Discussion Papers 244, Cowles Foundation for Research in Economics, Yale University.
    3. Feldstein, Martin S & Chamberlain, Gary, 1973. "Multimarket Expectations and the Rate of Interest," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 5(4), pages 873-902, November.
    4. J. M. Culbertson, 1957. "The Term Structure of Interest Rates," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 71(4), pages 485-517.
    5. Friedman, Benjamin M, 1971. "Econometric Simulation Difficulties: An Illustration," The Review of Economics and Statistics, MIT Press, vol. 53(4), pages 381-384, November.
    6. Smith, Gary, 1975. "Pitfalls in Financial Model Building: A Clarification," American Economic Review, American Economic Association, vol. 65(3), pages 510-516, June.
    7. Feldstein, Martin S & Eckstein, Otto, 1970. "The Fundamental Determinants of the Interest Rate," The Review of Economics and Statistics, MIT Press, vol. 52(4), pages 363-375, November.
    8. repec:bla:econom:v:40:y:1973:i:157:p:12-43 is not listed on IDEAS
    9. Ladenson, Mark L, 1971. "Pitfalls in Financial Model Building: Some Extensions," American Economic Review, American Economic Association, vol. 61(1), pages 179-186, March.
    10. Fair, Ray C & Malkiel, Burton G, 1971. "The Determination of Yield Differentials between Debt Instruments of the Same Maturity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 3(4), pages 733-749, November.
    11. Reuben A. Kessel, 1971. "The Cyclical Behavior of the Term Structure of Interest Rates," NBER Chapters, in: Essays on Interest Rates, Volume 2, pages 337-390, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

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