A State-Preference Approach to the Precautionary Demand for Money

THE STUDY SHOWS HOW THE PRECAUTIONARY DEMAND FOR MONEY CAN BE INCORPORATED INTO A PORTFOLIO SELECTION MODEL. IT IS A SIMPLIFIED PORTFOLIO SELECTION MODEL USING THE NOTION OF STATES OF NATURE. INTERPRETATION IS GIVEN TO THE TERM LIQUIDITY0IN THE CONTEXT OF SUCH A MODEL. THE RESTRICTIONS WHICH MUST BE PLACED ON AN INVESTOR'S UTILITY FUNCTION FOR A WELL-DEFINED PRECAUTIONARY DEMAND FOR MONEY TO EXIST ARE DETERMINED. IN A MARKET IN WHICH THERE IS A DISTRIBUTION OF PRICES FOR ANY SECURITY RATHER THAN A SINGLE EQUILIBRIUM PRICE, AN INVESTOR WILL PERCEIVE THE DISTRIBUTION OF PRICES WITH WHICH HE IS FACED AS BEING MORE VARIABLE IF HE MUST SELL THE SECURITY ON SHORT NOTICE THAN IF HE HAS MORE TIME IN WHICH TO SAMPLE POTENTIAL BUYERS.