Aswath Damodaran 99
Beyond the default spread
! Country ratings measure default risk. While default risk premiums and equity
risk premiums are highly correlated, one would expect equity spreads to be
higher than debt spreads. If we can compute how much more risky the equity
market is, relative to the bond market, we could use this information. For
example,
- Standard Deviation in Bovespa (Equity) = 36 %
- Standard Deviation in Brazil C-Bond = 28. 2 %
- Default spread on C-Bond = 6. 01 %
- Country Risk Premium for Brazil = 6. 01 % ( 36 %/ 28. 2 %) = 7. 67 %
! Note that this is on top of the premium you estimate for a mature market.
Thus, if you assume that the risk premium in the US is 4. 84 %, the risk
premium for Brazil would be 12. 51 %.
In In this approach, we scale up the default spread to reflect the additional risk in
stocks... This will result in larger equity risk premiums. There is a third
approach which is closely related where you look at the standard deviation of the
emerging equity market, relative to the standard deviation of the U.S. equity
market, and multiply by the U.S. equity risk premium. Thus, the equity risk
premium for an emerging market which is twice as volatiles as the the US
market should have an equity risk premium of 9.68% (twice 4.84%).
