A Reconsideration of the Role of Forward-Market Arbitrage in Keynes’s and Hicks’s Theories of the Term Structure of Interest Rates

Lucy Brillant ()
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Lucy Brillant: LEDi - Laboratoire d'Economie de Dijon - UB - Université de Bourgogne - CNRS - Centre National de la Recherche Scientifique, PHARE - Philosophie, Histoire et Analyse des Représentations Économiques - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique

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Abstract: This paper develops the relationship between Hicks's and Keynes's writings on the theory of the term structure of interest rates, and shows in detail how Hicks built on and extended Keynes's account. According to this theory, the level of the long-term interest rate is determined by expectations of future short-term rates. Keynes's thinking contained several notions – such as the preferred habitat of lenders, the theory of forward markets, and risk-premiums – which Hicks used to give a more complete theory of the term structure of interest rates. Besides implementing these notions in his own theory, Hicks introduced the concepts of the preferred habitat of borrowers, the liquidity risk premium, and arbitrageurs who can take advantage of spreads between spot and forward rates and eliminate risk premiums.

Keywords: arbitrageurs; borrowers; forward rates; expected short-term rates; lenders; risk premium; long-dated securities; preferred habitat; term structure of interest rate (search for similar items in EconPapers)
Date: 2014-12
Note: View the original document on HAL open archive server: https://ube.hal.science/hal-01696168v1
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Published in European Journal of the History of Economic Thought, 2014, 21 (6), pp.1085-1101

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