What is commonly used as a proxy for the risk-free rate in finance?

The risk-free rate is often represented by the yield on government securities, primarily because these securities are backed by the full faith and credit of the issuing government, which is considered unlikely to default. Among these, 10-year Treasury bonds are the most common proxy for the risk-free rate in finance. This is due to their relatively long duration, liquidity, and the fact that they are widely traded, providing a basis for comparison across various investment opportunities.

Using 10-year Treasury bonds as a proxy is particularly standard in models that evaluate investment performance and risk, such as the Capital Asset Pricing Model (CAPM), where the risk-free rate is a crucial component. The long duration of the 10-year bond also aligns well with many investment horizons, making it an appropriate benchmark for assessing expected returns against the inherent risks of other assets.

In contrast, corporate bonds, municipal bonds, and foreign government bonds carry varying levels of default risk and are influenced by their issuers' creditworthiness and local economic conditions. For instance, corporate bonds include credit risk, which can skew the perception of a risk-free rate, while the yield on municipal and foreign government bonds may also reflect differing risk profiles that make them less appropriate as a risk-free rate benchmark.