Risk-Free Rate
he risk-free rate is a
theoretical interest rate at which an investment may earn
interest without incurring any risk. The notion is used
extensively in option
pricing theory where derivatives
are valued with a risk neutral
assumption under which all assets may be assumed to have
expected returns
equal to the risk-free rate. The notion of a risk-free rate is
also used in Modern
Portfolio Theory.
In practice, the risk-free rate is often assumed to be
a short-term Treasury rate.