notes/10 - Projects/CSC/Chapter 7/Three Theories.md
2026-03-30 03:23:09 -04:00

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Markdown

- **Expectations Theory (A)** — Long-term rates reflect the market's _expectation_ of future short-term rates. An upward sloping curve means the market expects rates to rise. Nothing to do with preference for liquidity.
- **Liquidity Preference Theory (C)** — Investors _prefer_ short-term bonds because they're more liquid and less price-volatile. They'll only go long-term if paid a premium for the extra risk. This is the one your answer described.
- **Market Segmentation Theory (B)** — Different institutional players dominate different parts of the yield curve (banks = short-term, insurance companies = long-term). Supply and demand in each segment determines yields. This is the only theory that can explain _all_ yield curve shapes including inverted and humped.
A memory trick:
- **Expectations** = future rates
- **Liquidity** = pay me more to go long
- **Segmentation** = different players, different segments