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Tuesday, February 17, 2015

'Applying Keynes's Insights about Liquidity Preference to the Yield Curve'

Via email, a new paper from Josh R. Stillwagon, an Assistant Professor of Economics at Trinity College, appearing in  the Journal of International Financial Markets, Institutions & Money. The paper "applies some of Keynes's insights about liquidity preference to understanding term structure premia. The following is an excerpt paraphrased from the conclusion":

"This work uses survey data on traders' interest rate forecasts to test the expectations hypothesis of the term structure and finds clear evidence of a time-varying risk premium in four markets... Further, it identifies two significant factors which impact the magnitude of the risk premium. The first is overall consumer sentiment analogous to Keynes's "animal spirits"... The second factor is the level of and/or changes in the interest rate, consistent with the imperfect knowledge economics gap model [applied now to term premia]; the intuition being that the increasing skew to potential bond price movements from a fall in the interest rate [leaving more to fear than to hope as Keynes put it] causes investors to demand a greater premium. This was primarily observed in the medium-run relations of the I(2) CVAR, indicating that these effects are transitory suggesting, as Keynes argued, that what matters is not merely how far the interest rate is from zero but rather how far it is from recent levels."
This link is free for 50 days: http://authors.elsevier.com/a/1QYk23j1YpaN3o

    Posted by on Tuesday, February 17, 2015 at 09:41 AM in Academic Papers, Economics, Financial System | Permalink  Comments (7)


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