%0 Journal Article
%A Blitz, David
%T The Risk-Free Asset Implied By the Market: *Medium-Term Bonds Instead of Short-Term Bills*
%D 2020
%R 10.3905/jpm.2020.1.166
%J The Journal of Portfolio Management
%P jpm.2020.1.166
%X 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.
%U https://jpm.pm-research.com/content/iijpormgmt/early/2020/07/04/jpm.2020.1.166.full.pdf