The unbiased expectations theory assumes that investors do not consider securities with different maturities as perfect substitutes.

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Consider the core idea of the unbiased expectations theory (a.k.a. pure expectations theory): it posits that the shape of the yield curve is determined solely by market expectations of future short-term rates. If investors expect future short-term rates to rise, longer-term rates will rise accordingly, and if they expect rates to fall, long-term rates will fall. Now, evaluate the statement: 'The unbiased expectations theory assumes that investors do not consider securities with different maturities as perfect substitutes.' Under this theory, investors are indifferent between holding a sequence of short-term bonds or a single long-term bond only insofar as the expected returns (based on anticipated future rates) are the same. In other words, the theory treats different maturities not as perfect substitutes in practice because the premise is about expectations of rates driving the yield relationship, rather than asserting that maturities are perfect substitutes. Therefore, the assertion that investors do not consider securities with different maturities as perfect substitutes aligns with the idea that substitution is not guaranteed by mere maturity differences, but it still hinges on expectations about future rates for pricing. Consider the counterpoint: if investors did view maturities as perfect substitutes, long-term and rolling over short-terms would yield identical outcomes irrespective of rate expectations, which would flatten the yield curve in a way the theory does not require. Consequently, stating that investors do not treat different maturities as perfect substitutes captures a nuance of the theory’s premise, while suggesting a denial of substitutability would be inaccurate in typical presentations of the model. In short, the claim touches on how term structure is determined by rate expectations rather than a blanket substitution assumption, and the standard implication is that maturities are not guaranteed to be perfect substitutes, given the dependence on expected future rates.

The unbiased expectations theory assumes that investors do not consider securities with different maturities as perfect substitutes.

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