Page 132 - DECO402_Macro Economics

Unit-14: Contribution of Boumol and Tobin

RE = mR = Br Notes
The risk related to portfolio is measured from the standard deviation of R i.e., sR. Tobin has described
about the three types of investors. One-type of investors are those who are interested in facing risk
and they use their entire money in bonds for facing the risk. They face risk in exchange of unexpected
income of bonds. They are like gamblers. Second section is of plungers. They either invest their entire
money in bonds or keep it in cash form. These plunger natured persons either invest their entire
property or do not face a single risk.
But most of the investors are in third section. They are risk averters or diversifiers. Risk averters want
to save from that risk of loss that is related by keeping the bonds instead of money. They become ready
to face the risk only in that condition when they have expectation that they will get something extra
(income) from bonds, subject to whatever extra risk they face it brings more increments in resulting
income with it. Therefore, they will make their portfolio more diversified and will keep money and
cash both. Though no result or risk is gained from keeping the money, then also it is the liquid form
of assets that can anytime be used to purchase the bonds. To know about preference in risk and
expected result of risk averters, Tobin uses indifference curves of positive slope, which shows that
risk averters demand for more expected results to face more risk. It is shown in figure 14.2 in which
horizontal axis measures risk sR and vertical axis measures the unexpected results smR. Or line is
the budgetary line of risk averter. It shows those combinations of risk and expected result on which
basis he invests his portfolio of wealth in money and bonds. I and I are the indifference curves.
1 2
Indifference curve shows that it is indifferent with those all combinations of risk and expected result
which are situated on I curve. It gives the preference to the points situated on I curve instead of the
1
2
points situated on I curve. But the condition of balance between risk and expected result for the risk
1
averter will be available where it’s budgetary line will touch the indifference curve. Such point on
budgetary line and indifference curve I is T.
1

Task Express your views on Boumol’s Inventory Theoretic Approach.

The length of vertical curve in the lower part of figure shows that assets of which risk averter keeps
his portfolio in money and bonds. OC Line shows the risk as the proportion of part of total portfolio
kept in bonds. Therefore, the point E on this line drawn as a normal from point T determines the
mixed portfolio. There is OP as bond and PW as money.

Figure 14.2

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