What Is the “Risk-Free Rate” Typically Based on in Financial Models?

The risk-free rate is a theoretical rate of return for an investment with zero financial risk. In financial models, such as the Black-Scholes model, it is typically based on the yield of a short-term government security, such as a US Treasury Bill, which is considered to have the lowest possible credit risk.

The chosen maturity should match the time horizon of the financial instrument being valued, like the expiration of the option contract.