Liquidity Premium Theory Flashcards
long-term bonds…
have high interest rate risk sensitivity, investors should be compensated for this risk.
Liquidity Premium theory assumes…
that investors are not indifferent to risk, they are risk averse.
LPT recognises…
that investors demand a yield premium as compensation for investing longer term.
LPT suggests…
that forward rates include both investors’ expectations of future spot rates and liquidity premiums.
since implicit forward rates include a risk premium…
forward rates should be higher than expected future spot rates, means that forward rates are not unbiased estimators of expected future spot rates.
the liquidity premium causes…
forward rates to be consistently higher than the expected future spot rates.
problems with this theory
although LPT explains the upward trend of yield curve, it does not indicate the size of the risk premium.
risk premium rising uniformly for all maturites…
may not be the case.
risk premium rising uniformly for all maturities…
may not be the case.
