What does the long-term rate depend on? Fisher effect vs liquidity premium

Research output: Chapter in Book/Report/Conference proceedingChapter


Equation (3) implies that the yield spread, which is the long-term rate minus the short-term rate, constitutes the difference between the expected and the current inflation rate, the liquidity premium, and other factors. However, as will be discussed in the next section, we cannot use quantitative data for estimating the liquidity premium. Therefore, the transactions volume of 10-year interestbearing government bonds is adopted as a measure of the premium in this study. Hence, we can employ the following model to conduct the regression analysis: (4) where YieldSpreadt is the spread of the nominal interest rates at time t, Expinft is the difference between the expected and current inflation rate at t, Liqpremt is the transactions volume of the long-term bonds, a(=rr Lt - rr St) is the intercept, and e(=u Lt - u St) is the error term.4 β1 is the coefficient representing the Fisher effect of the expected inflation on the term structure of interest rates, and β2 is the liquidity premium effect on the term structure. YieldSpreadt and Expinft have been presented as percent per annum, and the logarithm of the transactions volume is presented as Liqpremt.

Original languageEnglish
Title of host publicationKeynes and Modern Economics
PublisherTaylor and Francis
Number of pages12
ISBN (Electronic)9781136338861
ISBN (Print)9780415469777
Publication statusPublished - 2012 Jan 1
Externally publishedYes

ASJC Scopus subject areas

  • Economics, Econometrics and Finance(all)
  • Business, Management and Accounting(all)


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