NERA report - Bias in indexed CGS yields as proxy for the CAPM Risk Free Rate - March 2007

In March 2007, NERA Economic Consulting released a preliminary report which identifies a potential bias in Treasury Indexed Bonds as a proxy for the real risk-free rate.

On the 31 May 2007 SP AusNet submitted to the AER a letter on remedying the use of biased raw yields on Commonwealth Government Securities (CGS) as a proxy for the risk free rate, attaching NERA’s preliminary report. SP AusNet indicated in that letter that a supplementary report from NERA would follow on the absolute bias in CGS.

SP AusNet submitted NERA’s second report to the AER on Thursday, 14 June 2007. After reviewing NERA's second report, SP AusNet considers there to be a compelling case that continued use of CGS yields to estimate the risk free rate without recognition of the relative and absolute bias would result in a significant underestimate of the allowed cost of capital. SP AusNet supports NERA's recommendation for correcting the bias when estimating the real risk free rate and submits that the AER adopt such an approach.