Performance Perspectives Blog

What IS risk-free?

by | May 27, 2010

I’m conducting a review of a client’s performance reports. When reporting by country, if there is no risk-free rate for that country, a zero value is used (e.g., for Sharpe ratio, Jensen’s alpha). Why?

Risk-free rates can be quite complex; perhaps more than they need to be.

I’m a US-based investor. My risk-free rate is the U.S. Treasury bill. I can put my money there or invest in something more risky, such as Vietnam equities. Vietnam, to my knowledge, has no risk-free rate. But why should I care; would I invest in them? No, if I’m looking for a risk-free rate it’s treasuries.

Well, what about the investor in Vietnam; what if he’s your client, what do you show? I’d pick a risk-free rate that this investor could invest in; since there is no rate for Vietnam, perhaps one from Australia, the UK, or the USA? Pick something that could be used, but don’t look for a collection of rates, one per country. The rationale behind this is lost on me. If you have a good argument for it, let me know.

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