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Another Look at Yield Spreads: The Role of Liquidity
Author(s) -
Kim Dong Heon
Publication year - 2008
Publication title -
southern economic journal
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.762
H-Index - 58
eISSN - 2325-8012
pISSN - 0038-4038
DOI - 10.1002/j.2325-8012.2008.tb00875.x
Subject(s) - liquidity premium , market liquidity , liquidity risk , yield (engineering) , liquidity trap , constraint (computer aided design) , monetary economics , economics , liquidity constraint , liquidity crisis , yield curve , cash , accounting liquidity , interest rate , finance , mathematics , materials science , geometry , metallurgy
Liquidity plays an important role in explaining how banks determine their allocation of funds. This paper examines whether this fact can explain yield spreads and the term structure of interest rates. The paper models banks' demand for liquidity in a manner similar to that often used to study household liquidity needs, namely, by using a cash‐in‐advance type model. The paper finds that the cash‐in‐advance constraint (liquidity constraint) plays an important role in determining yield spreads. The empirical part of the paper shows that the expectations hypothesis might be salvaged when account is taken of the liquidity premium and the risk premium.