The primary market for negotiable certificates of deposit, 1967-1971



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This study identifies and statistically specifies the demand and supply factors in the primary market for negotiable certificates of deposit (CDs). First a brief history of the use of certificates and the development of the CD market is presented. Then a theoretical demand function is developed, based on the theory of portfolio selection and risk aversion. Emphasis is placed on corporate influences as corporations are the primary source of funds to the CD market. The theoretical supply analysis rests on the application of the model of a multiple-product, price-discriminating firm to the commercial bank. The effect of combining a rising demand for bank funds and rising costs (to banks) of those funds is studied, and a basic CD supply relation is developed. Both demand and supply functions are formulated to allow for specific measure of any lag in the timing of adjustments by market participants. Monthly data series for the 1967-1971 period are computed and used in the regression analysis. Two different quantity measures are used. One emphasizes the flow of funds into the CD market; the other, the stock of CDs outstanding. Dummy variables are used to determine the degree of seasonality in the demand relation. Since shorter-term CDs were dropped from the regulation's coverage during the test period, a dummy variable is also used in the supply relation to capture the effectiveness of Regulation Q ceilings. The empirical evidence largely confirms the theoretical hypotheses. Significant 'price' and 'wealth' (or 'income') elasticities are revealed; the latter especially in line with those specified by such economists as Lee and Meltzer. The role of the eurodollar as a CD alternative is also discussed. This study is the only one known (to this author) to encompass periods of both monetary ease and stringency- as evidenced by the effectiveness of Regulation Q ceilings in holding down interest rates on bank time deposits. The findings of three earlier econometric studies of the CD market are compared with those presented here, however, and the general conclusion is reached that the basic behavior of CD market participants does not change, although their participation in the market may vary, during periods of tighter monetary policies. In this connection the relevance of the study to the current discussions among monetary theorists and financial authorities concerning the proper role of money and banking in the economy is also clearly indicated and discussed.



Certificates of deposit