Market Segmentation Theory

What Is Market Segmentation Theory?

Market segmentation theory is a theory that long and short-term interest rates are not connected with one another. It additionally states that the predominant interest rates for short, intermediate, and long-term bonds ought to be seen separately like things in various markets for debt securities.

Grasping Market Segmentation Theory

This theory's major decisions are that yield curves are determined by supply and demand powers inside each market/category of debt security maturities and that the yields for one category of maturities can't be utilized to foresee the yields for an alternate category of maturities.

Market segmentation theory is otherwise called the segmented markets theory. It depends on the conviction that the market for each segment of bond maturities comprises for the most part of investors who have a preference for investing in securities with specific spans: short, intermediate, or long-term.

Market segmentation theory further affirms that the purchasers and venders who make up the market for short-term securities have various qualities and inspirations than purchasers and dealers of intermediate and long-term maturity securities. The theory is to some extent in view of the investment propensities for various types of institutional investors, for example, banks and insurance companies. Banks generally favor short-term securities, while insurance companies generally favor long-term securities.

A Reluctance to Change Categories

A connected theory that explains upon the market segmentation theory is the preferred habitat theory. The preferred habitat theory states that investors have preferred scopes of bond maturity lengths and that most shift from their preferences provided that they are guaranteed higher yields. While there might be no identifiable difference in market risk, an investor acclimated with investing in securities inside a specific maturity category frequently sees a category shift as risky.

Suggestions for Market Analysis

The yield curve is a direct consequence of the market segmentation theory. Traditionally, the yield curve for bonds is drawn across all maturity length categories, mirroring a yield relationship between short-term and long-term interest rates. In any case, backers of the market segmentation theory recommend that looking at a traditional yield curve covering all maturity lengths is a pointless undertaking since short-term rates are not predictive of long-term rates.

Features

• Market segmentation theory states that long-and short-term interest rates are not connected with one another in light of the fact that they have various investors.
• Connected with the market segmentation theory is the preferred habitat theory, which states that investors like to stay in their own bond maturity range due to guaranteed yields. Any shift to an alternate maturity range is perceived as risky.