Singer - Terhaar: Which Risk Free Rate to Use?

I might be losing it at this point, but to calculate the E® on a segmented / integrated market for 2 different markets, do we use their respective risk-free rates? Or do we use a global risk free rate. I think I’m losing it because I realize this is probably a very very stupid question.

Actually I think this is a very good question because in the Exam 2 AM test for Schweser Practice Exam 1 I don’t think they specify which country the risk free rate is for. I think we can assume that it is the risk free rate of the investor’s country then? Anyway, we add the same given “risk free rate of return” to both markets in the solution. Question 4-B.

I think it would have to be the risk free rate of the local market… for example, if markets were completely segmented, it would be the RP in the local market anyway.

i think we use domestic market (local market is different from domestic market)

Actually, pimp, i think it’s a great question. I would use global RFR if you need to calculate the global ERP before doing the local ERP calcs, but then use the local market RFR to calculate the E® of the local market once the local ERP is calculated. That approach makes sense to me, but does it strike anybody as inconsistent?

Segmented markets have different RfRs Singer Terhaar estimates ERP (equity risk premium) Local E® = RFR + ERP Local RFRs dominate in segmented markets. Integrated markets have a common global RFR If you have a fractionally integrated market, I think you compute both a segmented and an integrated estimate and do a weighted average based on the degree of integration (0-100%).

but local rfr already reflects degree of market integration/segmentation.

i would use the investor Rf rate of his home country, no?

MaxTheDog Wrote: ------------------------------------------------------- > but local rfr already reflects degree of market > integration/segmentation. Hmm… you’re right. I’ll have to check. I guess you do a weighted average of ERPs, segmented and integrated, not weighted average of E®s. Then you use local RFR if you are predicting Local Market Returns, and you use global RFR if you have a world investor and he/she hedges currency returns.

if it helps … the cfai example and schweser are both the same - there is only one rf rate given and it appears to be the global as it is the same rate to calculate the sharpe ratio … peace.

What SS is this agian? I’ll check to see what STalla says.

SS 6

i think it would have to be domestic. There is no “risk-free” rate in a segmented market, right?

Stalla just says, “if the rf rate is 4%…” I’m gonna stick with my initial assumption and use the investors own Rf rate in his country.

Schweser Book 1 Exam 2 Question 4B: Step 1: Find the segmented and fully integrated risk premiums Step 2: Find the weighted average risk premium Step 3: Add the weighted average risk premium to the global risk free rate (only one RFR is given in the entire question)

it is the investors own rf in his country…big is right!

eastwest Wrote: ------------------------------------------------------- > it is the investors own rf in his country…big is > right! that is what i thought too, but anyway, i think only 1 rfr will be given as we dont really need to know rfr for S-T.

CFAI textbook Vol. 3 page 43 line number 8 > the (domestic) risk-free rate; and CFA textboook Vol. 3 page 48-51. Example 19. Only one risk free rate is given, it applies on all US and non-US Asset Class.

thats correct… i meant local rf from the perspective of the investor holding a portfolio in various markets. in vol. 3 example 19, they are talking about a US foundation that has asset classes such as non US equities, non US fixed income etc… so u compute RPs for all asset classes as usual… degree of integration, segmentation etc… and then, to compute the returns you use the US RFR…