Stochastic cash flow constraints and the term structure of interest

This paper attempts to provide a theoretical foundation for liquidity premia to be found in the term structure of interest rates. These premia arise from the borrowers' future availability of cash and from the lenders' future need for cash. In addition a third category of investors are active on the market: speculators who have no cash constraint and take positions on the basis of their expectations of future spot rates only. The interaction between these three groups yields an equilibrium term structure which is tested empirically; the test produces estimates of the relative weights of the groups in the determination of liquidity premia. Analysis of these weights indicates that there exists some market segmentation between bonds of different maturities.