A discussion on the Validity of Risk-free Interest Rates post European Debt Crisis

The concept of a workable risk-free rate is essential to many financial tools and equations, forming some of the inputs for popular models such as CAPM and the Black-Scholes formula. Despite their importance, risk-free rates have been used with very little questioning about how risk-free they really are. After the European debt crisis and the large economic fluctuations it bought, we saw countries such as Greece and Iceland, default. Therefore, the idea that a tangible asset can be assumed to be risk-free must be questioned. This paper aims to present a balanced argument and analyse the suitability of risk-free rates, post the European debt crisis, through analysis of the European Monetary Union and the circumstances, which led to the default of Greece, omitting Iceland from investigation as it is not a member of the Euro-zone. The paper will then suggest what is left for the European government bond market and present the idea of Eurobonds as a possible alternative to government bonds. Finally, it will summarise the Investigation and findings, drawing conclusions as to the usability of government bonds as risk-free rates.