Tobin criticized Keynes' assumption that individuals only hold assets as bonds or cash. Instead, Tobin proposed that individuals hold a portfolio of various assets to strike a balance between risk and return. These portfolios include money, bonds, property, and other assets. According to Tobin, individuals prefer less risk and are uncertain about future interest rates. They therefore choose a combination of less risky but less productive safe assets and more risky but more productive assets. Tobin also showed that an individual's demand for money is inversely related to the interest rate, as higher rates make money less attractive compared to bonds.

1. TOBIN’S THEORY OF
PORTFOLIO DM
Prof. Prabha Panth,
Osmania University,
Hyderabad

2. KEYNES DEMAND FOR MONEY
• Keynes assumed that public holds its
assets either as bonds or cash.
• Tobin has criticised this assumption.
• People hold their assets or wealth in
many forms – or in various “Portfolios”
• This includes:
a) Money, b) Bonds, c) Property, etc.
• Transaction DM may also be affected by
rate of interest.
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3. Tobin’s Portfolio DM
• According to Tobin, people hold a Portfolio
of Assets – some cash, and some bonds.
– Idle cash is safe (no risk), but earns zero
income or interest.
– Bonds earn interest, but they are risky.
Therefore people hold a balanced
combination of both safe and risky
portfolio of assets.
Depends on the individual’s attitude to
Risk.
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4. Tobin’s Portfolio DM
• According to Tobin, individuals
show “Risk Aversion”.
• They prefer less risk to more risk
at a given rate of interest.
• Also, they are uncertain about the
future rate of interest
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5. Tobin’s Portfolio DM
• But holding cash is unproductive, as it
earns no income.
• So they have to choose a combination
or portfolio of assets
– some less risky (safe) but less productive
-- some more risky but more productive.
The portfolio of assets depends on
the nature of the individual
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6. Tobin’s liquidity preference curve
• Like Keynes, Tobin shows the LP is
inversely related to rate of interest.
• When i is high, people change their
portfolio to bonds, and hold less cash
• When i is low, they prefer to hold
cash, and reduce the number of
bonds.
• Thus the Asset DM is inversely related
to the rate of interest.
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7. Tobin’s liquidity preference curveRateofinterest
Asset D for Money
0
DM
Asset D for Money
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8. Tobin’s Model
rs = expected real return on stocks
rb = expected real return on bonds
 e = expected inflation rate
W = real wealth

  
( / ) = ( , , , ),d e
s bM P L r r W
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9. Tobin’s Model
• Stocks and bonds are alternatives to money.
• An increase in i makes money less attractive,
reduces desired money holdings.
• The real return to holding money is -e.
• An increase in e is decrease in real return to
holding money, and cause a decrease in desired
money balances.
• And finally, an increase in wealth causes an
increase in the demand for all assets.
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