Costs of Adjustment, Portfolio Separation, and the Dynamic Behavior of Bank Loans and Deposits

Journal of Money, Credit, and Banking (November 1995) Vol. 27, No. 4, pp.955-974

Fox School of Business Research Paper

20 Pages Posted: 17 Jun 2014

See all articles by Elyas Elyasiani

Elyas Elyasiani

Temple University - Department of Finance

Kenneth J. Kopecky

Temple University - Department of Finance

David D. VanHoose

Baylor University - Department of Economics

Date Written: 1995

Abstract

In this paper we develop a model of the banking firm that enables us to test for portfolio separation. Our theoretical model generalizes existing intertemporal adjustment-cost models by assuming that these costs coexist simultaneously on both sides of the bank's balance sheet. The optimal deposit supply and loan demand functions that emerge from our extended model show that each of these functions depends both on one- and two-period quantity lags and the lagged, contemporaneous, and expected future values of interest rates, including loan, deposit, and short term borrowing (for example, federal funds) rates. Models exhibiting portfolio separation or asset-liability independence emerge as a special case of the extended model. This feature enables us to test conditions, paralleling those first highlighted by Sealey (1985), that are consistent with the portfolio separation hypothesis. When portfolio separation holds, deposit supply and loan demand depend only on a one period quantity lag and contemporaneous and expected future differentials of the own rate and the federal funds rate. Thus, the property of portfolio separation can be examined empirically by determining whether the zero restrictions required by that property are supported in the econometric estimates of the banks' deposit supply and loan demand functions.

Suggested Citation

Elyasiani, Elyas and Kopecky, Kenneth J. and VanHoose, David D., Costs of Adjustment, Portfolio Separation, and the Dynamic Behavior of Bank Loans and Deposits (1995). Journal of Money, Credit, and Banking (November 1995) Vol. 27, No. 4, pp.955-974; Fox School of Business Research Paper. Available at SSRN: https://ssrn.com/abstract=2451270

Elyas Elyasiani (Contact Author)

Temple University - Department of Finance ( email )

Fox School of Business and Management
Philadelphia, PA 19122
United States
215-204-5881 (Phone)
215-204-5698 (Fax)

Kenneth J. Kopecky

Temple University - Department of Finance ( email )

Fox School of Business and Management
329 Speakman Hall
Philadelphia, PA 19122
United States
(215) 204-8279 (Phone)

HOME PAGE: http://www.sbm.temple.edu/%7Ekkopecky/

David D. VanHoose

Baylor University - Department of Economics ( email )

P.O. Box 98003
Waco, TX 76798-8003
United States

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