Market segmentation theory is a modern theory that explains and pertains to the interest rates related to the investments and loans within a market. According to the market segmentation theory there is no relationship or no integrity among the short term and long term interest rates. Moreover the short term and long term markets are totally separate in terms of operations as a result there is no necessary relationship between the interest rate of long term and short term markets. This is due to the fact that the long term and the short term markets fall into two different categories. Due to these different categories the yield curve is also based on the supply and demand of the securities within different markets that fall on each maturity length.
The other name of the market segmentation theory is the segmented market theory and it is based on the idea that most of the investors have set preferences according to the term of the securities and the time span that is required to get these securities mature in order to finally invest in them. According to the market segmentation theory there are different segments of buyers, sellers and securities depending upon the relative term of the maturity of the security and each of them such as sellers and buyers cannot substitute others in different segments. If an investor tries to invest outside its segment of term or maturity he has to face additional risk that may be compensated as he is dared to take some additional risk.
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