risk-freerate,andgeometricaveragestoreflectourdesirefor
a risk premium that we can use for longer-term expected
returns.Wecanusethreeapproachestoestimatethecountry
risk premium:
- Country bond default spreads. While there are several
measuresofcountryrisk,oneofthesimplestandmosteasily
accessible is the rating assigned to a country’s debt by a
ratingsagency.Standard&Poor’s(S&P),Moody’sInvestors
Service,andFitchallratecountries.Theseratingsmeasure
defaultrisk(ratherthanequityrisk),buttheyareaffectedby
manyofthefactorsthatdriveequityrisk—thestabilityofa
country’s currency, its budget and trade balances, and its
political standing, for instance.
17 Theother advantage ofratings is that theycome with
default spreads over theU.S. treasurybond. Forinstance,
Brazil was rated B1 in early 2005 by Moody’s, and the
10-year Brazilian C-Bond, which is a dollar-denominated
bond, waspricedto yield 7.75percent, 3.50 percent more
thantheinterest rate (4.25percent) on a 10-yearTreasury
bond at the same time.
18 Analystswhousedefaultspreadsasmeasuresofcountry
risktypicallyaddthemontoboththecostofequityanddebt
ofeverycompanytradedinthatcountry.Ifweassumethat
thetotalequityriskpremiumfortheUnitedStatesandother
mature equity markets is 4.84 percent (which was the
historical premium through the end of 2004), the risk
premium for Brazil would be 8.34 percent.
2.Relativestandarddeviations.Therearesomeanalystswho
believe that the equity risk premiums of markets should
reflect the differences in equity risk, as measured by the
volatilities of equities in these markets. A conventional