The addition of the liquidity premium theory to the expectations hypothesis allows us to explain why:
A) yield curves usually slope upward.
B) interest rates on bonds of different maturities move together.
C) long-term interest rates are less volatile than short term interest rates.
D) yield curves are flat.

Question

Quizplus · Accepted Answer

The liquidity premium theory suggests that investors require a higher return for holding longer-term bonds because they are less liquid and more exposed to interest rate risk. Therefore, the addition of the liquidity premium to the expectations hypothesis explains why yield curves usually slope upward, as longer-term bonds have higher yields to compensate for the added risk.

The Addition of the Liquidity Premium Theory to the Expectations