In valuation, the risk-free rate is an anchor. It must match the currency of your cash flows and be stated transparently.
For Saudi valuations in SAR, two common errors appear repeatedly: using SAIBOR as the risk-free rate, or mixing USD risk-free rates with SAR cash flows. Both will quietly break an otherwise clean model.
This post covers two defensible methods for estimating a SAR-consistent risk-free rate.
What “Risk-Free” Means in a Valuation Model
A proper risk-free rate in valuation should be:
- Denominated in the same currency as the cash flows
- Matched in tenor to the duration of those cash flows (a 10-year benchmark is practical for long-duration models)
- Free of default risk, or explicitly adjusted if your market does not provide a perfect proxy
Approach A: Use a SAR Government Benchmark (Direct Method)
If you have access to a reliable SAR government yield curve, a long-tenor government yield is a straightforward risk-free proxy.
Pros:
- Correct currency
- Directly observable benchmark
Cons:
- Liquidity conditions in the SAR government bond market can differ from deep benchmark markets, introducing occasional noise
When using this approach, note the yield date, tenor, and any liquidity caveats in your assumption log.
Approach B: Build-Up Using the Peg (Transparent Method)
A practical and widely used approach is to start with a USD risk-free rate and add a Saudi sovereign default spread proxy:
R_f(SAR) = R_f(USD) + CDS(KSA)
This is transparent because each input is independently observable.
One integrity rule to follow: if you use a sovereign spread to convert R_f(USD) to R_f(SAR), do not then add another sovereign spread component elsewhere in your cost of equity or ERP without clearly explaining why. Double counting is a common - and often silent - modelling error.
Why SAIBOR Is Not a Risk-Free Rate
SAIBOR is a bank offered rate. It embeds bank credit risk, liquidity premiums, and funding conditions. It is appropriate for pricing floating-rate debt instruments, but it is not the right anchor for a valuation discount rate.
Illustrative Example
| Input | Rate |
|---|---|
| R_f (USD, 10-year) | 4.5% |
| CDS (KSA, 10-year) | 1.0% |
| R_f (SAR, implied) | 5.5% |
Label these as illustrative unless you are sourcing live market data at a specific date.
Pitfalls Checklist
- Currency mismatch - SAR cash flows discounted with a USD rate without conversion
- Tenor mismatch - short-dated risk-free rate applied to long-duration cash flows
- Double counting - sovereign risk embedded in both the risk-free rate build-up and again in the equity risk premium
This article is for educational purposes only. It explains valuation concepts and modeling choices. It is not investment advice, a recommendation, or a financial promotion. Examples use illustrative inputs. Verify all data using primary sources and consult an appropriately licensed professional before making financial decisions.
CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute. This content is not endorsed by or affiliated with CFA Institute.
Abdul Gaffar Mohammed, CFA
Treasury & Investment Professional