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.
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Famous quotes containing the word application:
“May my application so close
To so endless a repetition
Not make me tired and morose
And resentful of man’s condition.”
—Robert Frost (1874–1963)
“It is known that Whistler when asked how long it took him to paint one of his “nocturnes” answered: “All of my life.” With the same rigor he could have said that all of the centuries that preceded the moment when he painted were necessary. From that correct application of the law of causality it follows that the slightest event presupposes the inconceivable universe and, conversely, that the universe needs even the slightest of events.”
—Jorge Luis Borges (1899–1986)
“I think that a young state, like a young virgin, should modestly stay at home, and wait the application of suitors for an alliance with her; and not run about offering her amity to all the world; and hazarding their refusal.... Our virgin is a jolly one; and tho at present not very rich, will in time be a great fortune, and where she has a favorable predisposition, it seems to me well worth cultivating.”
—Benjamin Franklin (1706–1790)