Three term structures of interest rates theories
In Chapter 6 (starting on page 274), there is a brief discussion of three different Term Structure of Interest Rates theories. These are explanations of how the shape of yield curves for similar risk securities are formed. Which one of these three theories do you believe has the most merit in impacting yield curves? Do some research to support your answer. (You must pick one of the theories to support.)
When choosing other students’ posts to respond to, prioritize choosing those who back a different theory than the one you support.
You must post your own discussion thread before you will be able to view those of your classmates. Once you have posted your thread you need to post two replies. The replies should be specifically about what you agree and/or disagree with, and why, not just to say ‘Good job’ or ‘Nice post’ type comments.
Requirements: 1) No more than 2 fully developed paragraphs per post. 2) Should be in Your Own Words. 3) Do not use quotations from others. 4) Use APA citation when referencing sources.
ANSWER
Three term structures of interest rates theories
The market segmentation theory has more merit in impacting the yield curve. The market segmentation curve assumes that the borrowers and lenders ate in specific sections of the yield curve depending on their need to match assets and liabilities. The theory also assumes that the participants do not leave their preferred maturity sector, and thus the yield curve shape is determined by the demand and supply at different maturities (Nymand-Andersen, 2018). This theory can be used to explain any yield curve shape, thus having the most merit. The market segmentation theory makes more sense in this perspective in that the supply and demand for loans within a segment are what impact the yield curve. The segment can therefore explain the yield curve, and the supply and demand in that segment determine how it will look.
The yield curve can be said to be a direct result of the market segmentation theory. This means that it receives the most merit in terms of impacting the yield curve. The supply and demand in any market segment are what affect the yield curve, and thus, compared to the other two theories, in my opinion, the market segmentation theory makes more sense and has more merit. It can also explain the changing yield curve in different markets, and it is also predictable, and one can forecast by looking at the supply and demand in the market to determine how the yield curve will look like. The supply and demand in a market segment is the best explanation one can have for a yield curve, and thus, the market segmentation theory explains it best.
References
Nymand-Andersen, P. (2018). Yield curve modelling and a conceptual framework for estimating yield curves: evidence from the European Central Bank’s yield curves (No. 27). ECB Statistics Paper.
