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Profitability and the Time-Varying Liquidity Premium in the Term Structure of Interest Rates

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  • Tracy Mott
  • David Zen

Abstract

There have been numerous empirical studies of the term structure. Broadly, the evidence may be said to be consistent with some influence from expectations plus the existence of a liquidity premium. Long rates or the spread between long and short rates have seemed to be systematically related to expectations of future rates, though the expectations embodied in long rates or the spread are biased upwards as the liquidity preference theory would predict. The degree of influence of expectations and the behavior of the liquidity premium, however, have remained matters of controversy. In several recent studies (e.g., Robert Shillert 1979; Shiller, John Campbell, and Kermit Schoenholtz, 1983; David Jones and Vance Roley, 1983; Mankiw and Summers, 1984; and Mankiw, 1986) the expectations theory has performed poorly, even allowing for the existence of a constant liquidity premium, in attempts to test the joint hypothesis of rational expectations and the expectations theory. Shiller, Campbell, and Schoenholtz and Mankiw and Summers, among others, have suggested renewing the search for the determinants of a time-varying liquidity premium as a possibility for explaining what is going on but have had little success themselves in finding such.

Suggested Citation

  • Tracy Mott & David Zen, 1989. "Profitability and the Time-Varying Liquidity Premium in the Term Structure of Interest Rates," Economics Working Paper Archive wp_18, Levy Economics Institute.
    • Handle: RePEc:lev:wrkpap:wp_18
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    References listed on IDEAS

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    1. Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
    2. Tenny N. Lam & R. F. F. Dawson, 1972. "Books of Interest," Transportation Science, INFORMS, vol. 6(2), pages 214-216, May.
    3. Friedman, Benjamin M, 1979. "Interest Rate Expectations versus Forward Rates: Evidence from an Expectations Survey," Journal of Finance, American Finance Association, vol. 34(4), pages 965-973, September.
    4. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 14(1), pages 173-224.
    5. N. Gregory Mankiw, 1986. "The Term Structure of Interest Rates Revisited," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 17(1), pages 61-110.
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