Liquidity preference hypothesis


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Liquidity preference hypothesis

The argument that greater liquidity is valuable, all else equal. Also, the theory that the forward rate exceeds expected future interest rates.

Liquidity Preference Hypothesis

A theory stating that, all other things being equal, investors prefer liquid investments to illiquid ones. This is because investors prefer cash and, barring that, prefer investments to be as close to cash as possible. As a result, investors demand a premium for tying up their cash in an illiquid investment; this premium becomes larger as illiquid investments have longer maturities. This theory is more formally stated as: forward rates are greater than future spot rates. John Maynard Keynes was the first to propose the liquidity preference hypothesis. See also: Keynesian economics.