Smith Johnson*
A Safety-First Principle is used to derive models of the portfolio composition of the commercial banking sector in Pakistan. For econometric estimation we use data and for forecasting various models are estimated, with and without restrictions implied by the theory, such as symmetry on asset characteristics and the equivalent of Engel conditions. The best specification of the system of asset demand equations is a dynamic version which allows for adjustment costs or adjustment constraints in the alignment of the portfolio and which also disaggregates the various types of bank loans rather than treating them as perfect substitutes. That model provides information on the complements and substitutes amongst the assets that conforms to economic intuition. It also fits the data well and is a good forecaster and is shown to provide information that can assist the SBP in forecasting, as an example, real GDP. It is also noted that it dominates the expected utility model on all criteria.
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