Here is an interesting post by Damodaran on risk-free rates and risk premiums:
http://aswathdamodaran.blogspot.com/2011/09/risk-free-rates-and-value-dealing-with.html
It’s interesting, but I disagree with some of his stuff, for example:
The risk free rate is a reflection of what people expect in the overall economy for the foreseeable future
Usually that might be true, but when the Fed is deliberately manipulating rates, is it accurate to say the RFR really reflects people’s expectations? At the moment the RFR simply reflects the Fed’s desire to keep rates as low as possible, nothing to do with people’s expectations.
So the Fed is saying, “if you don’t want to take risk, this is what you’ll get, and I’m big enough to make sure that you get it.” Remember, if your duration matches your time horizon, and the US doesn’t default, that IS what you’ll get. If the Fed changes its mind later about rates, you still get the yield you purchased at as long as your duration matches your time horizon.
You could say, “Yeah, but I care about purchasing power.” Then you use the TIPs real rate instead. The Fed doesn’t have full control over that, and of course you can ask whether the inflation index numbers are going to be tampered with if the USG has to pay out in real terms based on them. That isn’t as risk-free as the nominal, but it does reduce the inflation risk aspect.
I haven’t read the Damodaran piece yet (or maybe I did earlier and don’t remember it was his), but the risk free rate is a reflection of what people expect in the overall economy for the foreseeable future in the same way that price is a reflection of demand. There’s another side to it, which is people’s willingness to take risk (not to mention the supply of treasury securities to begin with). If people are highly risk averse, the RFR will decrease to reflect that they don’t want to be anywhere else… part of that is about what they think about economic prospects, but part of it is also their own balance sheets.
There are plenty of people in this economy that are afraid to invest even if they think the economy is more likely than not to improve, and that’s because it only has to do somewhat less well than expected in order to have bad outcomes for them. So treasurys are low.
Remember that when treasury rates start to rise, as they will probably do one day, one of the first things that will happen is that stocks get whacked, and probably commodities too. Stocks effectively have a much longer duration than even long-term bonds, and so the loss in the bond world will be less than the loss in the stock world.
Once interest rates have gone back up to a normal level, and if that isn’t because of an inflation premium, then stocks can slowly start to do better. But it will be a long haul.
Didn’t anyone else go throught the CFA cirriculum and realize DDMs, sharpe ratios, and pretty much all other models are worthless?
Too many subpar individuals follow the same models hoping for extraordinary results. If the CFAI wanted to train better investment professionals, they’d say “this is what everyone else is doing, do something different.”
/Way off topic - I get far too many emails from the CFAI. What is it, one or two a day? I’m about to unsubscribe.
not worthless…though some material are more useful than others, its important to know all of the tools of the trade…as a practitioner, its up to you to decide what works best…CFAI isn’t there to make you outperform the market, its for you to get the training…outperformance is on you…
everybody is doing the same thing, some just do it better than others, as it is in all walks of life…
You know, I feel the same. After completing the CFA and other designations, I have yet to make my millions by cracking the market code. I always thought I was just too dumb to pick investments so I took Mr. Buffett’s first rule of investing which is ‘Never lose money.’ While I feel more informed and confident explaining after the fact market commentary, my investment speculations have never turned out in my favor.
#Vangaurd4Life
Also, I’m not kidding about Frankie’s birf certificate.
#Frankie2012