An Estimate of the Liquidity Premium

Abstract

The liquidity premium on U.S. government securities is quantitatively estimated and tabulated, using maturities from 1 month to 30 years. Unbiased forecasting by the market is assumed in order to get at expectations. The premium is estimated, first allowing it to take any shape and then constraining it to conform to a functional form which implies that the "normal" shape of the yield curve is monotonically increasing toward an asymptote. Tests for constancy of the premium over the post-Accord period, normality of the forecasting errors, and monotonicity of the premium with respect to maturity are performed, and the dependence of the premium on the level of interest rates is discussed.