The Risk-Free Asset Implied by the Market: Medium-Term Bonds instead of Short-Term Bills

23 Pages Posted: 25 Feb 2020

See all articles by David Blitz

David Blitz

Robeco Quantitative Investments

Date Written: December 2019

Abstract

In empirical tests of the CAPM, the theoretical risk-free asset is typically assumed to be 1-month Treasury bills. This paper examines the implications of a mis-specified risk-free asset, i.e. the possibility that the ‘true’ risk-free asset is a longer-maturity Treasury bond. A simple theoretical derivation leads to the testable prediction that low-beta (high-beta) stocks should then exhibit positive (negative) bond betas. We find strong empirical confirmation for these predictions. The market-implied risk-free asset can be pinpointed at medium-term (5-year) bonds. Concrete implications of this finding are a lower equity risk premium and a less steep security market line.

Keywords: asset pricing, risk-free asset, CAPM, equity beta, bond beta

JEL Classification: G11, G12, G14

Suggested Citation

Blitz, David, The Risk-Free Asset Implied by the Market: Medium-Term Bonds instead of Short-Term Bills (December 2019). Available at SSRN: https://ssrn.com/abstract=3529110 or http://dx.doi.org/10.2139/ssrn.3529110

David Blitz (Contact Author)

Robeco Quantitative Investments ( email )

Weena 850
Rotterdam, 3014 DA
Netherlands

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