Hi Folks, Just something I was thinking about this morning. I suspect this topic has been asked but it’s probably not bad for a revisit. Here’s the issue: US Treasuries are thought of as the standard Risk-free asset, at least from the perspective of a US investor. The argument is that the US Government has no credit risk, since it can print currency to satisfy its debts if necessary. Now US treasuries are subject to risk of inflation (which is what happens when governments print currencies to satisfy debts they cannot otherwise pay), so there actually is risk. As long as inflation is predictable, you can discount the inflation rate to get the true risk free rate, but is inflation really predictable? There is some risk there. There are TIPS, which are indexed to the inflation rate, but the increase in principal and coupon payments are taxable, so the inflation risk is reduced by the tax rate, but you still have inflation risk. The one exception is if you are a tax-exempt organization, like a non-profit endowment, foundation, or a pension fund. These guys have risk free assets in the form of TIPS, because they are tax-exempt. The rest of us have low-risk, but not risk free stuff. From a non-US perspective, the US treasury asset has currency risk, and if the US does print money to pay its debts, the value of the dollar will fall, and the return in the investor’s currency will fluctuate with the currency value. Therefore, from the perspective of a non-US investor, the T-bill is not risk free. Developed countries might substitute their own government debt for risk free assets (how do Europeans do this, since governments are the ones that borrow, but they no longer control the currency?), but in many other countries, governments face risks of default, so the assets are not risk free. so basically three questions: Are there any truly risk free assets, or is this just an academic fiction to enable nice models? What do non-US investors use for risk free assets in portfolios, especially if the dollar threatens to lose its place as the standard reserve currency? Would it be correct to assume that only tax-exempt US investors have access to a truly risk free asset?
Risk is defined as the standard deviation of NOMINAL returns and therefore, because there is 0 deviation in the nominal return on a treasury, it is risk free. up here in dog sleddin canada we use hockey sticks as our risk free asset. we hope in the coming years to get government securities like the US.
risk free implies credit risk free - not free of all risks. In India (to an extent proxy for emerging markets), risk free asset for a common man, is gold or real estate.