Overview of Market Segmentation Theory
The Market Segmentation Theory is one of the various theories that are associated with the yield curve. It is also known as the “segmented market hypothesis”. The Market Segmentation Theory tries to describe the relation of the yield of a debt instrument with its maturity period.
The Market Segmentation Theory explicates the reasons behind the prominence of normal yield curves over the other forms of yield curves.
Contention of Market Segmentation Theory
According to the Market Segmentation Theory the financial instruments that have separate term periods cannot be replaced with one another. This means that the demand as well as supply of debt instruments having long term periods and short term periods in the financial markets is ascertained separately.
Choices of Investors
The choices of investors are an important part of the Market Segmentation Theory. According to this theory the investors need to make their choices beforehand. It has been seen that the investors normally want to invest in debt instruments that have shorter term periods.
The main reason behind this is that the investors like to have investment portfolios that have a certain amount of liquidity. The short term debt instruments provide them with that luxury. Thus according to the Market Segmentation Theory the financial market that deals in debt instruments of shorter terms would experience more demand.
As per the Market Segmentation Theory if a particular debt instrument has higher demand it is supposed to cost more. The yield from the same would be relatively low. The fact that the yields of short-term debt instruments are lower than that of the long-term debt instruments could be understood from this explanation.
Market Segmentation Theory Facts
In the United States of America the yield curve of the dollar was reversed in the later stages of 2005 and early period of 2006. The yields of the short-term debt instruments were more than that of the long-term debt instruments. This could be explained by the Market Segmentation Theory.
As per the Market Segmentation Theory the investors might have preferred the long term debt instruments over the short term debt instruments and this could have contributed to the higher yields of short-term debt instruments over long-term debt instruments.