Ex Ante Bond Returns and the Liquidity Preference Hypothesis

Authors

  • Jacob Boudoukh,

    1. Stern School of Business, New York University and the NBER
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  • Matthew Richardson,

    1. Australian Graduate School of Management, University of New South Wales
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  • Tom Smith,

    1. Stern School of Business, New York University
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  • Robert F. Whitelaw

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    • *

      Boudoukh and Richardson are from the Stern School of Business, New York University and the NBER; Smith is from the Australian Graduate School of Management, University of New South Wales; and Whitelaw is from the Stern School of Business, New York University. We thank an anonymous referee, the editor, René Stulz, Dong-Hyun Ahn, Rob Stambaugh, and seminar participants at the University of Iowa and the Western Finance Association meetings for helpful comments and suggestions. Support from the Geewax-Terker program in financial instruments is much appreciated.


Abstract

We provide a formal test of the liquidity preference hypothesis (LPH), that is, the monotonicity of ex ante term premiums, using nonparametric estimates that do not require a structural model for conditional expected returns. Although the point estimates of the term premiums are consistent with previous conclusions in the literature regarding violations of the LPH, the test statistics are generally insignificant, even when powerful conditioning information is used. These results illustrate the importance of correctly accounting for correlations across maturities and of formally testing the inequality restrictions implied by the LPH.

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