Liquidity Theory of the Term Structure

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Liquidity theory of the term structure

A biased expectations theory that asserts that the implied forward rates will not be a pure estimate of the market's expectations of future interest rates because they embody a liquidity premium.

A theory stating that forward rates do not accurately predict future spot rates because forward rates are more liquid and therefore include a liquidity premium. The theory attempts to explain with the unbiased expectations theory is not borne out in real life.

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