Many valuation analysts are struggling with low or negative interest rates on sovereign debt for their risk-free rates in their models. In a recent interview, Michael Crain (Financial Valuation Group) asked Pablo Fernandez (University of Navarra) for some advice on this. Fernandez conducts global surveys every year about the risk premium. This year, he did the risk premium plus the risk-free rate.
Think total return: “Instead of thinking about the risk-free rate or the market risk premium, the more important thing to think about is the total required return,” says Fernandez. “That’s the number I’d spend my time on. That is, if you invest in some asset, what is your required return in order to compensate you for the risk that you foresee in holding the asset.”
“For example, in my survey I found that some people used the market short-term risk-free rate and some use negative figures, especially in Germany, for the risk-free rate,” he points out. “But others consider that we’re in an exceptional time so they don’t want to use the current market rate. On average people use a much higher number than the current risk-free rate. I think the historical average rate for Germany was about 2%, the current 10-year German government bond yield is near zero or even negative.”
Read the full interview: The full interview with Fernandez, which appeared in the July 2015 issue of Business Valuation Update, is now available at no charge on BVR’s Global Business Valuation Resource Centre.
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