Liquidity preference theory of interest rates

Longer-term holdings can expose investors to greater price uncertainty and reduced flexibility. A positive term or liquidity premium can therefore make longer yields exceed the path implied by expected short rates alone. This helps explain why an upward-sloping curve need not mean that short rates are expected to rise by the same amount. The premium is not necessarily constant and the theory is not a rule that every observed yield curve must slope upward. Strong expectations of falling short rates can still produce an inverted curve.