Application
The risk-free interest rate is highly significant in the context of the general application of Modern Portfolio Theory which is based on the Capital Asset Pricing Model. There are numerous issues with this model, the most basic of which is the reduction of the description of utility of stock holding to the expected mean and variance of the returns of the portfolio. In reality, there may be other utility of stock holding, as described by Shiller in his article 'Stock Prices and Social Dynamics,' (1984) Brooking Papers on Economic Activity, pages 457 to 511.
The risk free rate is also a required input in financial calculations, such as the Black–Scholes formula for pricing stock options and the Sharpe Ratio. Note that some finance and economic theories assume that market participants can borrow at the risk free rate; in practice, of course, very few (if any) borrowers have access to finance at the risk free rate.
Read more about this topic: Risk-free Interest Rate
Famous quotes containing the word application:
“My business is stanching blood and feeding fainting men; my post the open field between the bullet and the hospital. I sometimes discuss the application of a compress or a wisp of hay under a broken limb, but not the bearing and merits of a political movement. I make gruel—not speeches; I write letters home for wounded soldiers, not political addresses.”
—Clara Barton (1821–1912)
“Preaching is the expression of the moral sentiment in application to the duties of life.”
—Ralph Waldo Emerson (1803–1882)
“The receipt to make a speaker, and an applauded one too, is short and easy.—Take of common sense quantum sufficit, add a little application to the rules and orders of the House, throw obvious thoughts in a new light, and make up the whole with a large quantity of purity, correctness, and elegancy of style.”
—Philip Dormer Stanhope, 4th Earl Chesterfield (1694–1773)