Is Moss’s response regarding theories about the term structure of interest rates correct? A Yes. B No, preferred habitat theory does not make an assumption of market’s expectations. C No, pure expectations theory does not make an assumption of market’s expectations. Reading 46, EOC #25. Essentially what I’d like help on is understanding why pref habitat theory makes an assumption of the market’s expectations? I thought that the theory says, for example, insurance companies like to buy long-dated bonds in an effort to manage their assets/liabilities, and don’t let higher risk premiums of these long-dated securities get in the way of their investment? Thanks all!
Preferred habittat theory makes the assumption that short-term rates will almost always be lower than longer term rates because investors need an incentive to purchase longer-term bonds and bonds oustide their maturity preference.