The minimum required rate of return

Abstract

There is a puzzle in financial economics, called risk-free rate puzzle, named after Weil (1989). This puzzle consists of the observation that the risk-free rate is too low to be explained by actual consumption behaviour. Building upon previous research, and applying the concept of minimum compensation with expected utility, this article finds an equilibrium risk-free rate of 0.2% in real terms compared to an actual real risk-free rate of around 1%. Therefore, the puzzle is reversed; the actual risk-free rate is too high to describe investor sentiment.