Pure Expectations Theory

The Pure Expectations Theory suggests that the interest rate on a long-term bond reflects what investors expect future short-term interest rates to be. Essentially, if investors think short-term rates will rise, long-term rates will be higher, and if they expect rates to fall, long-term rates will be lower. The theory assumes investors are indifferent between locking in rates for longer or rolling over shorter-term investments, so the current long-term rates serve as a prediction of upcoming short-term rate changes. It helps explain how the market’s expectations influence interest rates across different maturities.