This paper examines the robustness of one month treasury bills as predictors of inflation. The evidence is inconsistent with the joint hypothesis that (1) the expected real rate of interest was constant for one-month bills and (2) that markets are efficient with regard to the time series of inflation. When the expected real rate of interest is set equal to the conditional expectation given the time series of real rates, the results are much more consistent with the efficient markets model. In more positive terms, the failure to confirm market efficiency appears to be the result of naive estimates of the expected real rate.

In this paper, the portfolio and the liquidity planning problems are unified and analyzed in one model. Stochastic cash demands have a significant impact on both the composition of an individual's optimal portfolio and the pricing of capital assets in market equilibrium. The derived capital asset pricing model with cash demands and liquidation costs shows that both the market price of risk and the systematic risk of an asset are affected by the aggregate cash demands and liquidity risk. The modified model does not require that all investors hold an identical risky portfolio as implied by the Sharpe-Lintner-Mossin model. Furthermore, it provides a possible explanation for the noted discrepancies between the empirical evidence and the prediction of the traditional capital asset pricing model.