The Liquidity Preference Theory and Yield Curve. Essentials of Investments. CPA Exam BAR. CFA Exam

The Liquidity Preference Theory says that the demand for money is not to borrow money but the desire to remain liquid. Liquidity preference theory is a model that suggests that an investor should demand a higher interest rate or premium on securities with long-term maturities that carry greater risk.

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What is Liquidity Preference Theory?
Liquidity preference theory is a model that suggests that an investor should demand a higher interest rate or premium on securities with long-term maturities that carry greater risk because, all other factors being equal, investors prefer cash or other highly liquid holdings.


According to this theory, which was developed by John Maynard Keynes in support of his idea that the demand for liquidity holds speculative power, investments that are more liquid are easier to cash in for full value. Cash is commonly accepted as the most liquid asset. According to the liquidity preference theory, interest rates on short-term securities are lower because investors are not sacrificing liquidity for greater time frames than medium or longer-term securities.