Hi Jason

I like your theory on the risk free rate (perhaps because I agree that a true theoretical risk free rate should be zero.) When I was in graduate school many years ago it was said to be 3%, and that always struck me as very arbitrary. The way I think about it now is that for short-term periods for US government securities, our proxy for risk free, it should approach zero, but, for the reasons you mention, should not be zero. For longer-term periods it should include inflation expectations so that the "real", rather than "nominal", risk free rate remains zero.

The risk free, or lowest possible risk investment rate, is also usually compared to available alternative investments, and by holding the asset one incurs opportunity cost. However, a risk free investment also solves practical problems that aren't addressed in theoretical discussions. Suppose I have a suitcase with $1 million dollars in it. There is risk of me holding that suitcase beyond what I could earn by making an investment. My house could burn, I could be robbed, I could lose the suitcase at the train station. Not so with a risk free investment, so perhaps there is an argument for a negative return on a risk free rate since it not only compensates for the risk of action, but also for the risk of inaction.

Thanks again for your interesting article.

Jeff Caira