TY - JOUR
T1 - The Risk-Free Asset Implied by the Market: <em>Medium-Term Bonds instead of Short-Term Bills</em>
JF - The Journal of Portfolio Management
SP - 120
LP - 132
DO - 10.3905/jpm.2020.1.166
VL - 46
IS - 8
AU - Blitz, David
Y1 - 2020/08/31
UR - http://jpm.pm-research.com/content/46/8/120.abstract
N2 - In empirical tests of the capital asset pricing model, the theoretical risk-free asset is typically assumed to be 1-month Treasury bills. This article examines the implications of a misspecified risk-free asset—that is, 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. The author finds 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.TOPICS: Portfolio theory, portfolio construction, derivativesKey Findings• In empirical tests of the capital asset pricing model, the theoretical risk-free asset is typically assumed to be 1-month Treasury bills. This article examines the implications of a misspecified risk-free asset—that is, 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.• The author finds strong empirical confirmation for these predictions and can pinpoint the market-implied risk-free asset at medium-term (5-year) bonds. Concrete implications of this finding are a lower equity risk premium and a less steep security market line.
ER -