nominalBrazilianreals(BR),is 12 percentandthat
the local currency rating assigned to the Brazilian
government isBBB.Ifthedefault spreadfor BBB
ratedbondsis 2 percent,therisklessBrazilian real
rate would be 10 percent.Thechallengesassociatedwithestimatingtherisk-freeratein
thelocal currencyareoftensodauntingin someemerging
marketsthatmanyanalystschoosetovaluecompaniesinU.S.
dollars (in Latin America) or euros (in Eastern Europe).
Risk Premium
Theriskpremiumisclearlyasignificantinputinallofthe
asset pricing models. In this subsection, we begin by
examining thefundamental determinants of risk premiums
and then look at practical approaches to estimating these
premiums.
What Is the Risk Premium Supposed to Measure?
Theriskpremiuminthecapitalassetpricingmodelmeasures
the extra returnthat would be demanded by investors for
shifting their money from a riskless investment to an
average-risk investment. It should be a function of two
variables:
1.Riskaversionofinvestors.Asinvestorsbecomemorerisk
averse, theyshould demand a larger premium for shifting
fromtherisklessasset.Whilesomeofthisriskaversionmay
beinborn,someofitisalsoafunctionofeconomicprosperity