Liquidity Preference Theory is a model that suggests that an investor should demand a higher interest rate or premium on securities with long-term maturities that carry greater risk because, all other factors being equal, investors prefer cash or other highly liquid holdings. The theory was first proposed by John Maynard Keynes in his 1936 book The General Theory of Employment, Interest and Money.The Liquidity Preference Theory has been used to explain various economic phenomena, such as the yield curve and the terms structure of interest rates. It is also sometimes used as a tool for making investment decisions. For example, if an investor believes that the market is overvaluing long-term securities relative to short-term securities (due to liquidity preference), they may choose to invest in short-term securities instead.
