[1] It is a segment of a three-part theory that works to explain the behavior of yield curves for interest rates.
The upwards-curving component of the interest yield can be explained by the liquidity premium.
Longstaff (1995)[2] calculates the upper bound for this premium by assuming that without trading restrictions, an investor with perfect market-timing ability can sell a security at its maximum price during the period in which the security is restricted from trading.
Consistent with the empirical literature the liquidity premium is positively related to the issuing firm's asset risk and leverage ratio and increases with a bond's credit quality.
The term structure of illiquidity spread has a humped shape, where its maximum level depends on the firm's leverage ratio.