Final answer:
No single theory consistently dominates the shape of the yield curve as the economy goes through business cycles. The Expectations Hypothesis, Market Segmentation Theory, and Liquidity Premium Theory each explain different aspects of the yield curve's shape, which can change due to varied economic conditions.
Step-by-step explanation:
As the economy moves through a business cycle, no single theory consistently dominates the shape of the yield curve. However, the Expectations Hypothesis, the Market Segmentation Theory, and the Liquidity Premium Theory provide different explanations for the prevailing yield curve shape under various economic conditions.
The Expectations Hypothesis suggests the yield curve reflects market expectations for future interest rates, which can change as the economy progresses through the business cycle. The Market Segmentation Theory posits that the yield curve is determined by the supply and demand for securities within specific maturity segments, which may shift during different stages of the business cycle. Finally, the Liquidity Premium Theory accounts for the added interest that investors demand for holding longer-term securities, as they are less liquid and carry more risk compared to short-term securities. This premium can vary throughout the business cycle as investors' risk tolerance changes.
It is difficult to state conclusively that any one of these theories dominates over the others as they may be influential at different times and under different conditions.