Session 6: Risk, Riskfree Rates and Equity Risk Premiums (a start)

We started this class by tying up the last loose ends with risk and return models, talking about how assuming that there are no transactions costs and private information can lead us all to hold the market portfolio, and how risk can be then measured as risk added to that portfolio. We did damn the CAPM with faint praise, arguing that it does not do very well at explaining differences in returns across companies, but that it does at least as well as the alternatives. We then started on the mechanics of the model, taking about risk free rates: how to estimate the risk free rate in a currency where there is no default free entity issuing bonds in that currency and why risk free rates vary across currencies. The key lesson is that much as we would like to believe that riskfree rates are set by banks, they come from fundamentals - growth and inflation. I have a post on risk free rates that you might find of use:
aswathdamodaran.blogspot.com/2...
In fact, risk free rates turned negative in a few currencies, upending what we know about risk free rates in. Here is my post on negative risk free rates.
aswathdamodaran.blogspot.com/2...
In the final few minutes of the session, we turned to equity risk premiums and how they are related to risk aversion.
Slides: pages.stern.nyu.edu/~adamodar...
Post class test: pages.stern.nyu.edu/~adamodar...
Post class test solution: pages.stern.nyu.edu/~adamodar...

[@Ashwantpakhrin]

Studied this today for CFA L2 cost of cap under corp issuers

[@heyya6493]

🥈 second
Thank you sir.
Much love from India

[@atharvabrahmecha8853]

If the rationale for defaulting is avoiding inflation and negative risk-free rates occur when a currency is deflationary, then why does Japan have a default spread at all?

[@kumarapillay3122]

rationale for defaulting is not only to avoid inflation but also to devalue a currency, so a government can still choose to default to reduce their value even though defaulting is an extreme method to devalue ur currency but the default risk remains nonetheless. Now coming to Japan, so u might know that japan inflation reached a 40 year high sometime last year and this has increased the currency value and Japan's government policy is structured to make japanese yen the currency with least value. So now basically what happens when a government defaults is their currency value reduces and when a government doesn't default, then their currency value increases as inflation increases. So now due to Japan's policy, the government might be like, oh no inflation is going up higher and hence our currency value also than our policy, so lets default and devalue our currency to our policy level. So there might still be default risk for a currency depending on the government policies.
So, basically what default spread measures, the orange part, is the possibility that the present government thats in control of the currency might default

[@mertozel8677]

@@kumarapillay3122 Thats an abysmal way to answer that. Value of the currency does not increase with inflation. Stupid comment.

[@kumarapillay3122]

@@mertozel8677 whats the correct answer then?...i would want to know the correct answer, so not to repeat this mistake

[@zan1971]

At the time you commented, Japanese risk free rate was 0.47%, real risk free rate was -3.669% and inflation was 4.30%.
Inflation + real risk free rate = Risk free rate
The entire default spread (which is the difference between the yield on a corporate bond and the yield on a risk-free government bond of the same maturity) is the equity risk premium.

[@sreans2007]

First 🙏

[@Abhshk_Krv]

@aswathd. hi, does this scamming work??

[@Martinit0]

Aswath Damodaran: "I guarantee, there will be no $3B [trading] losses if your mom is looking over your shoulder."

[@danielkrupah]

I think he talks too much than going straight to the point. It looks boring to me