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Inflation Uncertainty, Real-Interest-Rate Uncertainty, and the Liquidity Premium on Government Bonds

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  • Palmon, Oded
  • Parker, Jeffrey

Abstract

This paper shows that the components of uncertainty about nominal interest rates, real-rate uncertainty and inflation uncertainty, have different effects on the liquidity premium. An increase in inflation uncertainty should increase the equilibrium liquidity premium because investors reduce the effect of inflation uncertainty on the riskiness of their portfolios by holding more short-term bonds. In contrast, an investor can reduce the effects of uncertainty about future ex-ante real rates on portfolio return by matching more closely the maturity dates of the bonds held with the date on which the portfolio is to be liquidated for consumption purposes. Thus, the effect of an increase in real-rate uncertainty on the equilibrium liquidity premium is ambiguous, depending on the relative magnitudes of long-term and short-term saving and the proportions of short-term and long-term bonds issued by the government. Copyright 1991 by MIT Press.

Suggested Citation

  • Palmon, Oded & Parker, Jeffrey, 1991. "Inflation Uncertainty, Real-Interest-Rate Uncertainty, and the Liquidity Premium on Government Bonds," The Financial Review, Eastern Finance Association, vol. 26(4), pages 459-477, November.
    • Handle: RePEc:bla:finrev:v:26:y:1991:i:4:p:459-77
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    Cited by:

    1. Joe-Ming Lee, 2013. "Measuring the Mutual Fund Industry Risk Management and Performance Sustainability - Quantile Regression Model," Journal of Asian Business Strategy, Asian Economic and Social Society, vol. 3(4), pages 59-68, April.
    2. Chiang, Thomas C. & Kim, Doseong & Lee, Euiseong, 2006. "Country-fund discounts and risk: Evidence from stock market volatility and macroeconomic volatility," Journal of Economics and Business, Elsevier, vol. 58(4), pages 303-322.
    3. Joe-Ming Lee, 2013. "The Search of Structural Changes in Mutual Fund Industry-Based On the ARMAX-GJR-GARCH Model," Asian Journal of Empirical Research, Asian Economic and Social Society, vol. 3(3), pages 308-316, March.

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