The following is a statement from CFAI text SS 10 Reading 36 ( Returns Concept). Pg 107 3rd para “Industry practice has tended to favor use of long term goverment bonds in premium estimates despite the fact that such estimates are often used in one period models such as CAPM.” I do not understanstand the “one-period model such as CAPM”. How CAPM is a one period model and what are multiperiod models?
Well, all the elements in the CAPM refer to some particular time period (for example 5-year risk free rate). This discount rate is then used to discount cash flows generated in different periods. You have a series of cash flows and only a single discount rate. The right way would be to use different discount rates for cash flows generated in different periods. Also, by using a long-term government bond in determining CAPM elements we often mismatch maturities (for example 15-year government bond used in CAPM to discount cash flows up to 10 year from now). My 0.02$ P.S. I’m not an expert on this matter.