Preferred Habitat Theory

AAA

DEFINITION of 'Preferred Habitat Theory'

A term structure theory suggesting that different bond investors prefer one maturity length over another and are only willing to buy bonds outside of their maturity preference if a risk premium for the maturity range is available. The theory also suggests that when all else is equal investors prefer to hold short-term bonds in place of long-term bonds and that the yields on longer term bonds should be higher than shorter term bonds.

INVESTOPEDIA EXPLAINS 'Preferred Habitat Theory'

The preferred habitat theory is an expansion on the expectations theory which suggests that long-term yields are an estimate of the future expected short-term yields. The reasoning behind the expectations theory is that bond investors only care about yield and are willing to buy bonds of any maturity, which in theory would mean a flat term structure unless expectations are for rising rates. The preferred habitat theory expands on the expectation theory by saying that bond investor's care about both maturity and return. It suggests that short-term yields will almost always be lower than long-term yields due to an added premium needed to entice bond investors to purchase not only longer term bonds, but bonds outside of their maturity preference.

RELATED TERMS
  1. Biased Expectations Theory

    A theory that the future value of interest rates is equal to ...
  2. Interest Rate

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

    The idea that investors demand a premium for securities with ...
  4. Bond

    A debt investment in which an investor loans money to an entity ...
  5. Term Structure Of Interest Rates

    The relationship between interest rates or bond yields and different ...
  6. Expectations Theory

    The hypothesis that long-term interest rates contain a prediction ...
Related Articles
  1. The Advantages Of Bonds
    Investing

    The Advantages Of Bonds

  2. Corporate Bonds: An Introduction To ...
    Bonds & Fixed Income

    Corporate Bonds: An Introduction To ...

  3. Green Bonds: Fixed Returns To Fix The ...
    Bonds & Fixed Income

    Green Bonds: Fixed Returns To Fix The ...

  4. How Bond Market Pricing Works
    Bonds & Fixed Income

    How Bond Market Pricing Works

comments powered by Disqus
Hot Definitions
  1. Accounts Payable - AP

    An accounting entry that represents an entity's obligation to pay off a short-term debt to its creditors. The accounts payable ...
  2. Ratio Analysis

    Quantitative analysis of information contained in a company’s financial statements. Ratio analysis is based on line items ...
  3. Days Payable Outstanding - DPO

    A company's average payable period. Calculated as: ending accounts payable / (cost of sales/number of days).
  4. Net Sales

    The amount of sales generated by a company after the deduction of returns, allowances for damaged or missing goods and any ...
  5. Over The Counter

    A security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, etc. The phrase "over-the-counter" ...
  6. Earnings Before Interest After Taxes - EBIAT

    A financial measure that is an indicator of a company's operating performance. EBIAT, which is equivalent to after-tax EBIT ...
Trading Center