A
biased expectations theory that believes the
term structure reflects the expectation of the future path of
interest rates as well as
risk premium. The theory rejects the assertion that the
risk premium must rise uniformly with
maturity, but instead
profits that to the extent that the demand for and supply of funds do not match for a given maturity
range, some participants will shift to maturities showing the opposite imbalances, as long as they are compensated by an appropriate risk premium whose magnitude will reflect the extent of aversion to either price or
reinvestment risk.