Inflation Uncertainty, Real‐Interest‐Rate Uncertainty, and the Liquidity Premium on Government Bonds

Oded Palmon, Jeffrey Parker

Research output: Contribution to journalArticlepeer-review

2 Scopus citations

Abstract

This paper shows that the components of uncertainty about nominal interest rates, real‐rate uncertainty and inflation uncertainty, have different effects on the liquidity premium. An increase in inflation uncertainty should increase the equilibrium liquidity premium because investors reduce the effect of inflation uncertainty on the riskiness of their portfolios by holding more short‐term bonds. In contrast, an investor can reduce the effects of uncertainty about future ex‐ante real rates on portfolio return by matching more closely the maturity dates of the bonds held with the date on which the portfolio is to be liquidated for consumption purposes. Thus, the effect of an increase in real‐rate uncertainty on the equilibrium liquidity premium is ambiguous, depending on the relative magnitudes of long‐term and short‐term saving and the proportions of short‐term and long‐term bonds issued by the government.

Original languageEnglish (US)
Pages (from-to)459-477
Number of pages19
JournalFinancial Review
Volume26
Issue number4
DOIs
StatePublished - Nov 1991

All Science Journal Classification (ASJC) codes

  • Finance
  • Economics and Econometrics

Fingerprint Dive into the research topics of 'Inflation Uncertainty, Real‐Interest‐Rate Uncertainty, and the Liquidity Premium on Government Bonds'. Together they form a unique fingerprint.

Cite this