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Term Funding Premium—Time Is Money After All
Term premium plays an important role in understanding the evolution of interest rates, and has even been the target of monetary policy when short-term rates were at or near an effective lower bound. It is commonly defined as the difference between a long-term interest rate and the geometric average of short-term rates over the same horizon, making it unobservable. While many approaches exist to estimate term premium, they treat term premium as the market’s price for bearing interest rate risk. Although such frameworks have sufficed historically, they cannot explain the premium embedded in ...