Markets do not select for a liquidity preference as behavior towards risk

Abstract

Tobin (1958) has argued that in the face of potential capital losses on bonds it is reasonable to hold cash as a means to transfer wealth over time. It is shown that this assertion cannot be sustained taking into account the evolution of wealth of cash holders versus non cash holders. Cash holders will be driven out of the market in the long run by traders who only use a (risky) long-lived asset to transfer wealth. Moreover, bond holders do not survive in the presence of only stock holders even if the payoff of bonds dominates the dividend of stock.