Risk premium, liquidity premium, and expectations hypothesis in the treasury bill market

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Abstract

This paper examines whether the risk premium and the liquidity premium play an important role in explaining excess holding period return and whether two components can explain the empirical failure of expectations hypothesis. The paper finds from the study of U.S. Treasury Bill rates that the risk premium and the liquidity premium are important in explaining excess holding period return. However, the expectations hypothesis is not salvaged under the maintained hypothesis concerning the liquidity premium and risk premium although two premiums improve the forecastability of yield spread. The paper attributes the results to the possibility that the difference between the relative bid-ask spread of T-bill rates is not accurate measure for the time-varying liquidity.

Original languageEnglish
Pages (from-to)95-124
Number of pages30
JournalJournal of Economic Theory and Econometrics
Volume19
Issue number2
Publication statusPublished - 2008

Keywords

  • Expectations hypothesis
  • Liquidity premium
  • Risk premium
  • Term structure

ASJC Scopus subject areas

  • Economics and Econometrics

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