Update Parameters – Riskfree Rate at 2,42% per 31.12.2011
As of December 31, 2011 the long-term (i.e. 30 years) risk free rate amounted to 2,42% which is a dramatically low level as compared to its history. In fact, the risk free rate marked one after another all-time low in the middle of December and ended the year with another one. The most recent plunge reflects the prevailing uncertainty in financial markets in general.
After dipping to 2,62% at the end of September 2011, the risk free rate recovered but dipped again in the middle of November, thereby hitting 2,58%. Within ten days it shot back to over 3,00% to plunge to a new historic all-time low at 2,42% on December 15, 2011. In general, the risk free rate has been steadily declining since its peak at 4,09% at the beginning of April 2011.
An analysis of short- and mid-term risk free rates (i.e. one, three, five, and ten years) and the expected average inflation rates (source: EIU) for the according maturities shows that the real yield for the afore mentioned maturities is expected to be negative, ranging from -1,82% (one-year) to -0,36% (ten-year).
As initially suggested, the currently low levels of the risk free rate reflect the uncertainty and fear in financial markets. The German Government Bonds, on which the calculation of the risk free rate according to Svensson is based on, are considered a safe haven. The currently unstable market situation on financial markets, the ongoing European Government debt crisis which emerged from the Greek debt crisis, and the inability of European politicians to calm markets or provide promising solutions, support a more conservative investor behavior among European investors in general. December was characterized by a continuing stream of bad news such as the announcement of the rating agency Standard & Poor’s that it put its long-term sovereign ratings on 15 members of the Eurozone on “CreditWatch with negative implications” or the downgrade of Belgium’s credit ratings by Moody’s in the middle of December. A “flight into quality” often goes along with such events and explains – at least partly – the recent declines of the risk free rate.
The calculation of the risk free rate is based on the yield curve according to Svensson, the parameters of German Government Bonds and the according spot rates.
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