Abstract for CGBCR Discussion Paper 4
Abstract for CGBCR Discussion Paper 4‘Another look at yield spreads: The role of liquidity’
by Dong Heon Kim
November 2002, Centre for Growth and Business Cycle Research Discussion Paper Series, University of Manchester, No. 4. Download PDF file (465KB).
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 used to study household need for liquidity, namely, by using a cash-in-advance type model. The paper finds that the shadow price of the cash-in-advance constraint plays an important role in determining yield spreads. The empirical part of the paper shows that the expectations hypothesis might be salvaged under the maintained hypothesis concerning the liquidity premium and risk premium.