Biased Expectations Theory


DEFINITION of 'Biased Expectations Theory'

A theory that the future value of interest rates is equal to the summation of market expectations. Proponents of the biased expectation theory argue that the shape of the yield curve is created by ignoring systematic factors and that the term structure of interest rates is solely derived by the market's current expectations.

BREAKING DOWN 'Biased Expectations Theory'

Two common biased expectation theories are the liquidity preference theory and the preferred habitat theory. The liquidity preference theory suggests that long-term bonds contain a risk premium and the preferred habitat theory suggests that the supply and demand for different maturity securities are not uniform and therefore there is a difference risk premium for each security.

  1. Systematic Risk

    The risk inherent to the entire market or entire market segment. ...
  2. Flat Yield Curve

    A yield curve in which there is little difference between short-term ...
  3. Interest Rate

    The amount charged, expressed as a percentage of principal, by ...
  4. Liquidity Preference Theory

    The idea that investors demand a premium for securities with ...
  5. Yield Curve

    A line that plots the interest rates, at a set point in time, ...
  6. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments ...
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