Editing Risk-free rate (section)

==Proxies for the risk-free rate==
[[File:EuriborChart12m3m1w.svg|thumb|350px|[[EURIBOR]] is used as a proxy for the risk-free rate in European contexts. Euribor-12m (red), 3m (blue), 1w (green) value]]

The return on domestically held short-dated government [[bond (finance)|bond]]s is normally perceived as a good proxy for the risk-free rate. In [[business valuation]] the long-term yield on the [[US Treasury bonds|US Treasury coupon bonds]] is generally accepted as the risk-free rate of return. However, theoretically this is only correct if there is no perceived risk of default associated with the bond. Government bonds are conventionally considered to be relatively risk-free to a domestic holder of a government bond, because there is by definition no risk of default – the bond is a form of government obligation which is being discharged through the payment of another form of government obligation (i.e. the domestic currency).<ref>{{cite book |last1=Tobin |first1=James |authorlink1=James Tobin |last2=Golub |first2=Stephen S. |title=Money, Credit and Capital |page=16 |date=1997 |isbn=978-0070653368 |publisher=McGraw-Hill Education}}</ref> In fact, default on government debt does happen, so if in theory this is impossible, then this points out a deficiency of the theory. Another issue with this approach is that with coupon-bearing bonds, the investor does not know ex-ante what his return will be on the reinvested coupons (and hence the return cannot really be considered risk-free).

Some academics support the use of swap rates as a measurement of the risk-free rate. Feldhütter and Lando state that: "the riskless rate is better proxied by the swap rate than the Treasury rate for all maturities."<ref>{{cite conference |last1=Feldhütter |first1=Peter |last2=Lando |first2=David |title=Decomposing Swap Spreads |date=May 3, 2007 |conference=EFA 2006 Zurich Meetings |url=https://ssrn.com/abstract=687378 |doi=10.2139/ssrn.687378 |page=31}}</ref>

There is also the risk of the government 'printing more money' to meet the obligation, thus paying back in lesser valued currency. This may be perceived as a form of tax, rather than a form of default, a concept similar to that of [[seigniorage]]. But the result to the investor is the same, loss of value according to his measurement, so focusing strictly on default does not include all risk.

The same consideration does not necessarily apply to a foreign holder of a government bond, since a foreign holder also requires compensation for potential foreign exchange movements in addition to the compensation required by a domestic holder. Since the risk-free rate should theoretically exclude any risk, default or otherwise, this implies that the yields on foreign owned government debt cannot be used as the basis for calculating the risk-free rate.

Since the required return on government bonds for domestic and foreign holders cannot be distinguished in an international market for government debt, this may mean that yields on government debt are not a good proxy for the risk-free rate.

Another possibility used to estimate the risk-free rate is the inter-bank lending rate. This appears to be premised on the basis that these institutions benefit from an implicit guarantee, underpinned by the role of the monetary authorities as 'the lendor of last resort.' (In a system with an [[endogenous money]] supply the 'monetary authorities' may be private agents as well as the central bank – refer to Graziani 'The Theory of Monetary Production'.) Again, the same observation applies to banks as a proxy for the risk-free rate – if there is any perceived risk of default implicit in the interbank lending rate, it is not appropriate to use this rate as a proxy for the risk-free rate.

Similar conclusions can be drawn from other potential benchmark rates, including AAA-rated corporate bonds of institutions deemed '[[too big to fail]].'

One solution that has been proposed for solving the issue of not having a good 'proxy' for the risk-free asset, to provide an 'observable' risk-free rate is to have some form of international guaranteed asset which would provide a guaranteed return over an indefinite time period (possibly even into perpetuity). There are some assets in existence which might replicate some of the hypothetical properties of this asset. For example, one potential candidate is the [[consol (bond)|'consol' bonds]] which were issued by the British government in the 18th century.