Risk-Free Rate

Huge Dispersion Of The Risk-Free Rate And Market Risk Premium Used By Analysts In 2015

Huge Dispersion Of The Risk-Free Rate And Market Risk Premium Used By Analysts In 2015

Pablo Fernandez

University of Navarra – IESE Business School

Alberto Ortiz Pizarro

University of Navarra, IESE Business School

Isabel Fernández Acín

University of Navarra

October 31, 2015

Abstract:

We look at the Risk-Free Rate (RF) and the Market Risk Premium (MRP) used by analysts in 2015 to value companies of six countries.

The dispersion of both, the RF and the MRP used, is huge, and the most unexpected result is that the dispersion is higher for the RF than for the MRP.

We also find that some analysts have more freedom than others do. The data permits other comparisons. For example: Does it make sense that the average MRP used for Germany is higher than the average MRP used for France, Italy, Spain or the UK?

Most of the analysts use a RF higher than the yield of the 10-year Government bonds. A reason for it and for the huge dispersion may be the activity of the European Central Bank (ECB). The risk-free rate is the required return to Government bonds when nobody (not even the ECB) manipulates the market. A question arises: May we consider the Quantitative Easing (QE) implemented by the ECB in 2014 and 2015 “market abuse”, “market manipulation”, a way of “altering competitive markets”…?

Huge Dispersion Of The Risk-Free Rate And Market Risk Premium Used By Analysts In 2015 – Introduction

RF and MRP used in 156 valuation reports

We revised more than 1,000 analyst reports about companies with headquarters in six countries: France, Germany, Italy, Spain, UK and USA. We looked for reports that indicated the Risk-Free Rate (RF) and the Market Risk Premium (MRP) used by the analyst in the valuation. We found only 156. Exhibit 1 contains the date, the company of the financial analyst, the company valued, and the RF and MRP used. The analysts belong to 35 different companies and the reports refer to 99 different companies.

Figures 1 and 2 contain the Risk-Free Rate (RF) and the Market Risk Premium (MRP) used in 2015 in by the financial analysts in the 156 reports. The dispersion is huge.

Table 1 contains the statistics of the RF, MRP and (RF + MRP) that appear in Figure 1. The most unexpected result is that the (Standard deviation / average) is higher for RF than for MRP in the six countries: the dispersion is higher for the RF used than for the MRP used.

The reader can do also other comparisons and assessments. For example: Does it make sense that the average MRP used for Germany is higher than the average MRP used for France, Italy, Spain or the UK? Does it make sense that the MRP and the RF used have positive correlation only in France?

Risk-Free Rate

Risk-Free Rate

Risk-Free Rate

The statistics of table 1 can be compared with the statistics of a survey that was conducted on April 2015 (see Table 2). It can be seen that:

  • The (average RF) used by analysts is substantially higher than the (average RF) of the survey.
  • The (average MRP) is not substantially different,
  • The average (RF + MRP) used by analysts is substantially higher than the average (RF + MRP) of the survey.

Risk-Free Rate

2. Evolution of the 10-year Government bonds yield for the six countries

The anomalous low yields on the Government bonds in 2014 and 2015 (see Figure 3) may have some influence on the results presented on the previous section. Figure 3 suggests three pairs of countries with RF moving quite close: Italy-Spain, Germany-France and US-UK.

Risk-Free Rate

A comment about the Quantitative Easing (QE) implemented by the ECB in 2014, 2015… It is just a strange synonym for “print a lot of money (euros) and buy many, many bonds of the countries in the EU”. By doing so, bond prices increase (and bond yields decrease) dramatically. Some people refer to this “QE” as “market abuse of the ECB”, “market manipulation”, “altering competitive markets”, “expropriation of savings”… We agree with all this definitions: they are clearer than “QE”.

3. Degrees of freedom of different analysts

A closer look at Exhibit 1 permits to find four different patterns of analyst houses. We can see that there companies with their analysts using (for companies of the same country):

a) The same RF and same MRP
b) The same RF and different MRP
c) Different RF and same MRP
d) Different RF and different MRP. Among these we find the analysts of Spanish companies that belong to Deutsche Bank (see table 3). Other companies where the analysts have a lot of freedom are Jefferies, Morgan Stanley, Natixis, Societe Generale (although not in the USA) and UBS.

See full PDF below.

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