Hi Jason,

That is radical thinking and I enjoyed the article. I agree with you that concept of ‘risk free’ asset is indeed vague. I also think the concept of using GDP provides a good theoretical framework for capturing the minimum rate of return required for various asset classes. But I also see certain problems with this model:

1. GDP is an ex post number. The forward GDP is know with little certainty. The spot RFR (I will use ‘RFR’ though I agree with your idea that it is not a risk free rate of return) is know with certainty and could be locked. This helps the investor to compare the spread over the opportunity cost of funds employed for a project/asset. GDP becomes a variable component in my equation and thus increases the noise related to the required return.
2. RFR could be locked for a long term, maybe 10 years or above, disregarding the liquidity premium as the time frame increases. This helps in discounting a stream of cash flows far into the future. Again, GDP would be variable and known with little certainty for so many years.
3. The RFR is a comparable proxy across borders. Often, GDP numbers may have some amount of noise or lag in the way different economies capture them.
4. A big problem with real GDP is stripping out the inflation rate. The CPI/WPI seldom reflects the true level of inflation in an economy. The figure that flashes in the news reports is barely reflective of what I end up spending, year over year. On the contrary, The RFR seems more tangible in terms of what I would earn over an asset, say a G-Sec or any other proxy.

These are merely opinions and I would like to understand if I am missing the big picture or perhaps your perspective. The GDP could be a better tool theoretically, but it lacks the pragmatic appeal of providing the right proxy to the RFR. I would love to hear if you have any thoughts on this.

Regards,

Jimmy