Valuing emerging markets companies : new approaches to determine the effective exposure to country risk

The aim of this paper is to propose new methods to measure the effective exposure to country risk of emerging-market companies. Starting from Damodaran (2003), we propose seven new approaches and a revised CAPM for emerging markets companies. The “Prospective Lambda” represents the effective exposure according to analysts’ estimates of growth. The “Relative Lambda” relies on the firm value estimated through a relative valuation. The “Retrospective Lambda” represents the ex-post effective exposure to country risk. The “Company Effective Risk Premium” is a generalization of the Retrospective Lambda, and expresses the premium effectively requested by investors to invest in that specific company in the past year. “The Actual Lambda” and the “Company Actual Risk Premium” represent, respectively, the actual exposure to country risk of a company and the actual premium requested by investors to invest in that specific company. The “Industry Lambda” reflects the median exposure to country risk of the industry in which the company belongs. We tested our new measures of exposure to country risk on the Latin American emerging markets companies according to the classification of the MSCI Emerging Markets Latin America Index. The results confirm that the new approaches can be effectively applied by financial analysts to stable-growth companies that operate in emerging markets and to mature markets companies that operate in emerging markets, providing with a more reliable estimate of both the premium effectively requested by investors in the past and the actual premium. Applying the new approaches, the cost of equity reflects the effective exposure of a company to country risk without being over- or underestimated, as is the case with other existing approaches.

Markov Switching Risk Premium and the term structure of interest rates. Empirical evidence from US post-war interest rates

This paper considers the basic present value model of interest rates under rational expectations with two additional features. First, following McCallum (1994), the model assumes a policy reaction function where changes in the short-term interest rate are determined by the long-short spread. Second, the short-term interest rate and the risk premium processes are characterized by a Markov regime-switching model. Using US post-war interest rate data, this paper finds evidence that a two-regime switching model fits the data better than the basic model. The estimation results also show the presence of two alternative states displaying quite different features.

Prêmio sobre o risco (risk premium) dos títulos soberanos e política fiscal discricionária vs. regras de política fiscal para um país em desenvolvimento: o caso do Brasil

O projeto de pesquisa é parte do projeto entitulado "Credibilidade de Políticas Monetárias e Fiscais para o Brasil: Risco Soberano, Instituições, Âncoras Nominais, e Acesso aos Mercados Financeiros Internacionais". Dentro do atual plano de estabilização, um estudo empírico sobre a economia brasileira fornece um exemplo vívido do impacto de vários fatores, como o grau de institucionalização das políticas monetárias e orçamentárias que tem sido utilizadas desde a implementação do Plano Real, que aumentariam a credibilidade, sustentando a política cambial e o fluxo positivo do capital internacional, na percepção do mercado do risco de suspensão de pagamento (default risk) da dívida externa de um país em desenvolvimento. O foco dentro deste projeto de pesquisa será na questão de pesquisa: "Prêmio sobre o risco (risk premium) dos títulos soberanos e política fiscal discricionária vs regras de política fiscal para um país em desenvolvimento: o caso do Brasil".

Foreign Direct Investment and Country Risk::Is There Evidence of 'Malign Investment in the Former Soviet States'

This paper examines the relationship between concepts of MNE bargaining power and broader concepts of political power. It notes that the analysis of MNE bargaining power presents a number of puzzles from the perspective of political theory. These puzzles arise, in part, from the fact that the overlap between traditional concepts of MNE bargaining power and broader concepts of political power is only a partial one. Despite these problems, it is suggested that political- theory-based approaches can add realism to our understanding of bargaining power.

Brazilian equity risk premium analysis: A macroeconomic approach

Double Degree Masters in Economics Program from Insper and NOVA School of Business and Economics

The Shape of the Risk Premium: Evidence from a Semiparametric Garch Model.

We examine the relationship between the risk premium on the S&P 500 index return and its conditional variance. We use the SMEGARCH - Semiparametric-Mean EGARCH - model in which the conditional variance process is EGARCH while the conditional mean is an arbitrary function of the conditional variance. For monthly S&P 500 excess returns, the relationship between the two moments that we uncover is nonlinear and nonmonotonic. Moreover, we find considerable persistence in the conditional variance as well as a leverage effect, as documented by others. Moreover, the shape of these relationships seems to be relatively stable over time.

The impact of country risk on international real estate returns

Commercial real estate investors have well-established methods to assess the risks of a property investment in their home country. However, when the investment decision is overseas another dimension of uncertainty overlays the analysis. This additional dimension, typically called country risk, encompasses the uncertainty of achieving expected financial results solely due to factors relating to the investment’s location in another country. However, very little has been done to examine the effects of country risk on international real estate returns, even though in international investment decisions considerations of country risk dominate asset investment decisions. This study extends the literature on international real estate diversification by empirically estimating the impact of country risk, as measured by Euromoney, on the direct real estate returns of 15 countries over the period 1998-2004, using a pooled regression analysis approach. The results suggest that country risk data may help investor’s in their international real estate decisions since the country risk data shows a significant and consistent impact on real estate return performance.

The importance of the volatility risk premium for volatility forecasting

In this paper, we study the role of the volatility risk premium for the forecasting performance of implied volatility. We introduce a non-parametric and parsimonious approach to adjust the model-free implied volatility for the volatility risk premium and implement this methodology using more than 20 years of options and futures data on three major energy markets. Using regression models and statistical loss functions, we find compelling evidence to suggest that the risk premium adjusted implied volatility significantly outperforms other models, including its unadjusted counterpart. Our main finding holds for different choices of volatility estimators and competing time-series models, underlying the robustness of our results.

Financial systems and mechanisms of growth in different conditions of country risk

This article uses panel data from 1976 to 2003 to investigate the ways in which banking and stock markets influence economic growth in situations of high and low country risk. The mean and Standard Deviation (SD) of country risk are adopted to classify 28 countries into Low Risk Low Volatility (LRLV) and High Risk High Volatility (HRHV) subgroups. Through the technique of error correction-based panel co-integration developed by Westerlund (2007), several results are obtained. First, LRLV countries can expand the capitalization of stock market to enhance long-term economic growth. Second, HRHV countries, on the other hand, use two distinct strategies to promote long-term economic growth. Initially they develop their equity markets, which promote economic growth directly. Strengthened equity markets, in turn, aid in the development of credit markets, which subsequently brings an economic boom. Finally, regardless of selected subgroups, the contribution of stock market capitalization to economic growth appears to be substantially larger than that of bank credit, highlighting the importance of stock markets.

Estimating the equity risk premium for economies in the Asian region

The Equity Risk Premium (ERP) is widely used in economic and financial analysis, yet it is difficult to find empirical estimates of the ERP that are generally accepted. The paucity of data in Asian economies exacerbates the problems of estimation. This study estimates the ERP for the larger market-orientated Asian economies and compares the estimates with those of the United States. Surprisingly, of the seven economies examined, the ERP of four cannot be statistically differentiated from that of the United States.

Monetary policy and country risk

This article develops an econometric model in order to study country risk behavior for six emerging economies (Argentina, Mexico, Russia, Thailand, Korea and Indonesia), by expanding the Country Beta Risk Model of Harvey and Zhou (1993), Erb et. al. (1996a, 1996b) and Gangemi et. al. (2000). Toward this end, we have analyzed the impact of macroeconomic variables, especially monetary policy, upon country risk, by way of a time varying parameter approach. The results indicate an inefficient and unstable effect of monetary policy upon country risk in periods of crisis. However, this effect is stable in other periods, and the Favero-Giavazzi effect is not verified for all economies, with an opposite effect being observed in many cases.

The risk premium on brazilian government debt, 1996-2002

The goal of this paper is to identify the determinants of the risk premium on Brazilian government debt. As the risk premium is a component of the interest rate set by the Brazilian central bank, its reduction would make it possible for the central bank to cut interest rates to levels compatible with a higher economic growth environment. The empirical evidence presented in this paper does not reject the hypotheses that fiscal solvency and the size of the public debt affect the risk premium as measured by the spread over treasury bills of the Brazilian C-bond.

A systematic component of the jump-risk premium in an AJD model

We develop an affine jump diffusion (AJD) model with the jump-risk premium being determined by both idiosyncratic and systematic sources of risk. While we maintain the classical affine setting of the model, we add a finite set of new state variables that affect the paths of the primitive, under both the actual and the risk-neutral measure, by being related to the primitive's jump process. Those new variables are assumed to be commom to all the primitives. We present simulations to ensure that the model generates the volatility smile and compute the "discounted conditional characteristic function'' transform that permits the pricing of a wide range of derivatives.