does not make sense. If stocks always beat riskless
investmentsinthelongterm,stocksshouldberisklesstoan
investor with a long time horizon.
Country Risk Premiums
Inmanyemergingmarkets,thereisverylittlehistoricaldata
andthedatathatexistsistoovolatiletoyieldameaningful
estimateoftheriskpremium.Toestimatetheriskpremiumin
thesecountries,letusstartwiththebasicpropositionthatthe
risk premium in any equity market can be written as:
Thecountrypremiumcouldreflecttheextrariskinaspecific
market. This boils down our estimation to answering two
questions:
1.Whatshouldthebasepremiumforamatureequitymarket
be?
- How do we estimate the additional risk premium for
individual countries?
Toanswerthefirstquestion,wewillmaketheargumentthat
theU.S. equitymarket isa maturemarketandthatthereis
sufficient historical data in the United States to make a
reasonable estimate oftherisk premium. In fact,reverting
back to our discussion of historicalpremiums in theU.S.
market, we use thegeometric average premium earned by
stocksoverTreasurybondsof4.84percentbetween 1928 and
- Wechoose thelong time period to reduce standard
error,theTreasurybondtobeconsistentwithourchoiceofa