What is the riskfree rate? A Search for the Basic Building Block

Authors

Aswath Damodaran, New York University - Stern School of BusinessFollow

JEL Code

G11. G12, G31

Abstract

In corporate finance and valuation, we start off with the presumption that the riskfree rate is given and easy to obtain and focus the bulk of our attention on estimating the risk parameters of individuals firms and risk premiums. But is the riskfree rate that simple to obtain? Both academics and practitioners have long used government security rates as riskfree rates, though there have been differences on whether to use short term or long- term rates. In this paper, we not only provide a framework for deciding whether to use short or long term rates in analysis but also a roadmap for what to do when there is no government bond rate available or when there is default risk in the government bond. We look at common errors that creep into valuations as a consequence of getting the riskfree rate wrong and suggest a way in which we can preserve consistency in both valuation and capital budgeting.

Recommended Citation

Damodaran, Aswath (2020) "What is the riskfree rate? A Search for the Basic Building Block," Journal of New Finance: Vol. 1: No. 3, Article 4.
DOI: 10.46671/2521-2486.1010
Available at: https://jnf.ufm.edu/journal/vol1/iss3/4

Submission Date

November 2020

Approval Date

12-12-2020

Publication Date

12-15-2020