The Term Structure of Liquidity Premium

We analyze the term structure of Treasury liquidity premium (LP). Through a model where illiquidity shocks are alleviated by holding Treasuries, we show that LP term structure is shaped by expectations of future market liquidity, liquidity term premium, and Treasury supply. As predicted, the LP term structure is downward-sloping in recessions but upward-sloping in booms, and forward LP predicts future LP and market liquidity. Furthermore, LP is quantitatively important for monetary policy pass-through: LP dampens the pass-through of interest rate policy yet strengthens the pass-through of quantitative easings. We also use LP to infer the term structure of Treasury safety premium.

Keywords: Liquidity Premium, Term Structure, Monetary Policy

Suggested Citation: Suggested Citation

Joslin, Scott and Li, Wenhao and Song, Yang, The Term Structure of Liquidity Premium (March 23, 2021). USC Marshall School of Business Research Paper, Available at SSRN: https://ssrn.com/abstract=3476730 or http://dx.doi.org/10.2139/ssrn.3476730