Choosing a Monthly Risk-Free Rate for Portfolio Returns
Summary
The document addresses how to select a risk-free return when portfolio performance is measured monthly. Its central point is that a five-year Treasury yield does not provide a known risk-free return over a one-month holding period: the bond’s market price can change before maturity, so its monthly return is uncertain. A one-month Treasury bill more closely matches the measurement interval because its return over that period is known at the outset, subject to the assumption that the government repays its debt.
The response also notes that current practice often uses overnight risk-free-rate swap curves, such as SOFR or €STR, with other overnight indexed swap curves sometimes used for legacy reasons. It does not validate the proposed method of averaging five-year yields and converting that average into a monthly rate. The appropriate proxy depends on the return horizon and convention being used, and the discussion does not cover further details such as daily compounding or historical data alignment.
Key ideas
- A five-year Treasury yield does not make a one-month holding-period return risk free.
- A one-month Treasury bill better matches monthly return measurement because its period return is set in advance.
- Risk-free status relies on the assumption that the government repays its obligations.
- Modern benchmarks often use overnight risk-free-rate swaps or related overnight indexed swap curves.
- The monthly conversion of an averaged five-year yield is not established as appropriate by the response.
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# How do I have to calculate the risk free rate of my two asset portfolio? # How do I have to calculate the risk free rate of my two asset portfolio? Good afternoon everyone! I have a question regarding the risk free rate of my two asset portfolio. For my course, we have to create a two asset portfolio with the time frame of 2015-2020 with monthly returns. For the risk free rate, I have utilised the 5 year T-Bill because it has the same maturity as the project and also does not have any reinvestment risk since the T-Bills are zero-coupon bonds. However, I am unsure about my approach for the monthly risk-free rate, which I need since all of my returns of my assets are also monthly. As of now, I took the yield of a 5-year T-Bill calculated the average yield of a 5-year T-bill from 2015-2020. Since the yield of the T-Bills are denoted in yearly terms, I took the caculated average yield of those five years and plotted the number in the following formula: monthly rf yield = LN(1+avg. annual rf yield)/12 This gave me the avg. monthly rf rate. Is this approach appropiate or should I approach this problem in a different way? Kind regards ## Answer by Richard Hardy (score 2) https://quant.stackexchange.com/a/82139 Working on a monthly basis, the monthly return on a 5-year treasury bond is not known in advance, so it is not risk free. The same is true for any instrument with a maturity above 1 month. The monthly return on a 1-month T-bill is known in advance (assuming the U.S. government never goes bankrupt and always repays their creditors), so this an actual risk-free rate. However, see AKdemy's answer in this thread on what rates are used as risk-free ones in the current (2025) practice. I quote: > RFR swap rates (SOFR for USD, €STR for EUR for example) are used, but you usually have a choice for other swap curves (legacy reasons) like different OIS swaps (e.g. the Fed funds swaps).
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