What is the term structure of interest rates and the yield curve, and what do they explain?
Now we are going to hold the risk structure of interest rates—default risk, liquidity, and taxes—constant and concentrate on what economists call the term structure of interest rates, the variability of returns due to differing maturities. As Figure 6.4, “Risk premiums and bond spreads during the Great Depression, 1929–1939” reveals, even bonds from the same issuer, in this case, the U.S. government, can have yields that vary according to the length of time they have to run before their principals are repaid. Note that the general postwar trend is the same as that in Figure 6.1, “The risk structure of interest rates in the United States, 1919–2008”, a trend upward followed by an equally dramatic slide. Unlike Figure 6.1, “The risk structure of interest rates in the United States, 1919–2008”, however, the ranking of the series here is much less stable. Sometimes short-term Treasuries have lower yields than long-term ones, sometimes they have about the same yield, and sometimes they have
