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 allows us to explain the upward slope of yield curves as it states that investors demand a premium for holding long-term bonds due to the increased risk and uncertainty associated with tying up their money for a longer period of time. This premium is added to the expected future short-term rates, which causes long-term rates to be higher than short-term rates, resulting in an upward sloping yield curve.

The Addition of the Liquidity Premium Theory to the Expectations