A World With No Risk-Free Asset

When I wrote that The Laws of Capitalism Are Being Rewritten earlier this week, I didn’t expect it to get as big of a reaction as it did. It was cool to see everyone’s responses to me, with a lot aspects that I hadn’t considered myself.

The key to what I was trying to say (or ask) was this:

It is now commonly thought that the risk-free rate is the center of the financial universe and that the prices of all assets revolve around it. But what happens when the risk-free rate slowly ceases to exist. Or becomes a negative number?

It looks like the folks at Research Affiliates have been pondering the same idea. Chris Brightman is out with a new letter tackling the idea of The Death of the Risk-Free Rate:

1. Abandoning the assumption of a positive risk-free rate alters our conceptions of money, monetary policy, and investment risk. Managing volatility, the traditional measure of risk, may now prevent us from achieving our investment objectives.

2. Direct money creation—like dropping money from a helicopter—is the widely discussed next step in central bank monetary policy experiments. Such direct money printing raises the long-run risk of inflation.

3. Today’s fear of deflation has produced a sale on inflation hedges such as commodities, bank loans, high-yield bonds, REITs, and emerging market equities. Investors can protect their portfolios from inflation and improve their expected returns by diversifying into such cheap inflation-hedging asset classes.

I send you there now for the whole thing. I think this is a concept worth pondering over the weekend.


Death of the Risk-Free Rate (Research Affiliates)