Friday, May 7, 2010

Justifying the risk free rate

One of the commonest assumptions in financial mathematics is that the yield on government bonds represents a risk free rate which can be used to benchmark return versus risks on other investments. In good times, it's a fair assumption; when the markets are falling like dominoes, it's not.

Buttonwod muses on the issue:

A related issue is the use of government bonds as the core holding for pension funds, on the grounds that these are the closest match to the company's liabilities. Again, it may be the case that, say, Shell's promise to pay its pensioners is stronger than the British or Dutch government's pledge to repay its debts in full. (There is a philosophical point, as well. The rationale for private sector pension funds is that they reduce the burden on future taxpayers. But a fund investing in government bonds is simply a claim on future tax revenues.)

No comments:

Post a Comment