Internal consistency of risk free rate and MRP in the CAPM

Table 1: AAA to BBB spreads at 1 year maturity
Sampling period Spread
Average pre 2009 0.42%
Average post 2008 1.62%
Ratio pre and post 2008 3.8
November 2011 1.5%
Ratio November 2011 to pre 2008 Average 3.6
Source: Bloomberg, CEG analysis
4.2.1. RBA estimates of risk premiums relative to CGS
60. The RBA has produced a chart showing movements in risk premiums measured
relative to CGS yields 13 on corporate bond of various credit ratings and on near
riskless swap transactions (Figure 6 below). 14
61. The chart shows that all spreads on lower rated bonds increased in the second half of
2011 as CGS yields fell. Notably, the increase in spreads on AA corporate bonds was
higher than the increase in spreads on AAA rated debt considered in the previous
section and the increase in spreads on near risk free swaps shown in Figure 6 from
the RBA above.
62. This is what one would expect in a period of rising risk aversion, namely, widening
spreads and spreads widening most on higher risk assets. Similarly, the increase in
spreads on A and BBB rated bonds was higher than the increase in spreads on AA
rated bonds.
13 That is, the difference in yields on corporate bonds and CGS.
14 Swap transactions do not involve any exchange of principle. If a counterparty defaults the only values potentially at ‘risk’
are then prevailing differences between short term interest rates and the agreed fixed rate in the contract.
Competition Economists Group
www.CEG-AP.COM
14