Portfolio Behaviour in a Flow of Funds Model for the Household Sector in India

Abstract

We estimate a flow of funds model for the household sector in India, within the Almost Ideal Demand System (AIDS) framework, and examine the demand for money and the substitution effects between money and other financial assets. The restricted long-run model, obtained using cointegration techniques, provides stable equilibrium relationship between I(1) variables and broadly satisfies the axioms of rational choice in consumer demand theory. We find that financial sector reform exerts a significant impact on the interest rate structure and household portfolio preferences; specifically, there is strong substitutability among risk-free assets and a possible speculative effect in the stock market, while the exchange rate strongly influences the demand for money. These findings all have important policy implications.

Notes

This article is based on a chapter of Tomoe Moore's PhD thesis carried out at Loughborough University [ Moore, 2003 ]. We thank, without implicating, Kunal Sen for kindly providing his data at an early stage of the project, and Kunal Sen and Rajendra Vaidya for several helpful conversations on the material in this article. We also thank two anonymous referees and the Guest Editor (Colin Kirkpatrick) of this journal and participants in the Finance and Development conference (University of Manchester, 5–6 April, 2002) for their useful comments on different drafts of this article. We are grateful to the Department for International Development (DFID) for funding this research under the ‘Finance and Development Research Programme’, contract No. RSC106506. However, the interpretations and conclusions expressed in this article are entirely those of the authors and should not be attributed in any manner to either DFID or any other institutions with which the authors are associated.

For a discussion of the main developments in the literature on finance and development, stemming from the well-known work by Ronald McKinnon and Edward Shaw in 1973, see Evans, Green and Murinde [ 2002 ].

One of the authors has proceeded further to estimate and simulate a complete flow of funds model for India, based on a 4-sector disaggregation [ Moore, 2003 ].

Work on data for other sectors of the economy is reported by Moore [ 2003 ]. 1993–94 was the last year for which comprehensive flow of funds data were available for India.

Superscript τ refers to variables in real terms. Non-superscripted variables are in nominal terms.

Current wealth (W_t ) is the sum of end of last period wealth, current saving and capital gains or losses.

See Reserve Bank of India Monthly Bulletin, various issues, and Reserve Bank of India [ 2000 ].

For the complete data set see Moore [ 2003 ].

Hence, reported household holdings of foreign currency assets were negligible.

Note that a negative sign implies an increase in liability of -LA.

The VAR was of order 2.

We acknowledge, with thanks, the comment made by an anonymous referee on this point.

The detailed test statistics are available from the authors on request.

Adam [ 1999 ] and Jenkins [ 1999 ] find a similar result in portfolio studies of Kenya and Zimbabwe, respectively.

In the presence of higher inflation, returns to capital may be more unpredictable [ Perraudin, 1987 ; 755].

Unitary income elasticity is typically found in traditional demand for money functions [for example, Chow, 1966 ; Laidler, 1966 ].

Additional information

Notes on contributors

Tomoe Moore

This article is based on a chapter of Tomoe Moore's PhD thesis carried out at Loughborough University [ Moore, 2003 ]. We thank, without implicating, Kunal Sen for kindly providing his data at an early stage of the project, and Kunal Sen and Rajendra Vaidya for several helpful conversations on the material in this article. We also thank two anonymous referees and the Guest Editor (Colin Kirkpatrick) of this journal and participants in the Finance and Development conference (University of Manchester, 5–6 April, 2002) for their useful comments on different drafts of this article. We are grateful to the Department for International Development (DFID) for funding this research under the ‘Finance and Development Research Programme’, contract No. RSC106506. However, the interpretations and conclusions expressed in this article are entirely those of the authors and should not be attributed in any manner to either DFID or any other institutions with which the authors are associated.