Wednesday, November 23, 2011

Is there a risk-free rate of return?

It has always been the case that there is an explicit risk free rate of return for benchmarking performance. It has usually been Treasury bills for the US and short-term rates for domestic G10 countries, but it is becoming clear that in the 21st century there will not be a risk-free rate. There is no meaning to the concept.
The idea is a risk free rate of return is even odder for the EU where there is now a differential between the pay-off of bondholders with a provision of the latest sovereign debt bail-out. The private investors will not get 100 cents on the dollar. They have to take a haircut, but government lenders will receive all of their principal.

A decade ago there was talk that there would be no risk free bonds available to investors. Now there is no risk free asset. There is no greater change in financial markets.

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