Financial Innovation and Money Demand: Theory and Empirical Implementation
48 Pages Posted: 20 Apr 2016
Date Written: January 1, 1991
Empirically, traditional money demand equations are frequently characterized by periods of "missing money" , unstable parameters, and autocorrelated errors. The common practice to solve these problems consists of changing the specification of the regressions once the shifts (which are usually associated to financial innovation) are identified. This paper provides an alternative approach to dealing with the unobservable process of financial innovation. It consists of modelling financial innovation as shocks that have permanent effects on the money demand, analogous to productivity shocks in production functions. This paper describes the theoretical model used and shows the failure of traditional money demand equations using cointegration techiques. It describes a simple GLS-iterative econometric model which allows the authors to recover the path of financial innnovation and obtain sensible estimates of the relevant elasticities. It also shows Monte Carlo simulations to evaluate the behavior of the estimation procedure for particular samples and data generating processes, and to study how robust the procedure to some deviations from the basic assumptions is.
Keywords: Economic Theory & Research, Currencies and Exchange Rates, Fiscal & Monetary Policy, Debt Markets, Emerging Markets
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
Infrastructure, Geographical Disadvantage, and Transport Costs
By Nuno Limão and Anthony J. Venables
Trade Policy and Economic Performance in Sub-Saharan Africa
By Dani Rodrik
Did External Barriers Cause the Marginalization of Sub-Saharan Africa in World Trade?
By Alexander J. Yeats, Azita Amjadi, ...
Trade in International Transport Services: The Role of Competition
By Joseph F. Francois and Ian Wooton
What Can Be Expected from African Regional Trade Arrangements?: Some Empirical Evidence
North-South Trade: Is Africa Unusual?
Open Economies Work Better! Did Africa's Protectionist Policies Cause its Marginalization in World Trade?
By Francis Ng and Alexander J. Yeats
Geographical Disadvantage: A Heckscher-Ohlin-Von Thunen Model of International Specialization
By Anthony J. Venables and Nuno Limão
International Capital Mobility, Public Investment and Economic Growth
Africa's Role in Multilateral Trade Negotiations
By Zhen Kun Wang and L. Alan Winters