Another look at yield spreads: The role of liquidity

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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.

Original languageEnglish
Pages (from-to)952-970
Number of pages19
JournalSouthern Economic Journal
Issue number4
Publication statusPublished - 2008 Apr

ASJC Scopus subject areas

  • Economics and Econometrics


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