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Title:Fundamental uncertainty, portfolio choice, and liquidity preference theory PDF Logo
Authors:Pasche, Markus
Issue Date:2009
Series/Report no.:Jena economic research papers 2009,085
Abstract:One of Keynes' core issues in his liquidity preference theory is how fundamental uncertainty affects the propensity to hold money as a liquid asset. The paper critically assesses various formal representations of fundamental uncertainty and provides an argument for a more boundedly rational approach to portfolio choice between liquidity and risky assets. The choice is made on the basis of individual beliefs which are subject to mental representations of the underlying economic structure. Self-consciousness arises when the agent is aware of the fact that beliefs are dispersed among agents due to the absence of a true model. Responding to this fact by increasing liquidity preference is rationalized by the higher ex post performance of choice. Moreover, we analyze the case that the portfolio is partially financed by debt. It is explored how fundamental uncertainty affects the volume of the portfolio and hence money and credit demand as well as the probability of debt failures.
Subjects:liquidity preference
portfolio choice
self-confidence
self-consciousness
fundamental uncertainty
bounded rationality
Keynes
Knight
JEL:G11
D81
E41
B31
Document Type:Working Paper
Appears in Collections:Jena Economic Research Papers, MPI für Ökonomik

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