illiquid. This approach will understate the equity risk
premiums in those markets.
- Default spreads plus relative standard deviations. The
country default spreads that come with country ratings
provide an important first step, but still only measure the
premium for defaultrisk. Intuitively, wewould expect the
countryequity risk premium to be largerthan thecountry
defaultriskspread.Toaddresstheissueofhowmuchhigher,
welook atthevolatilityof theequitymarket ina country
relativetothevolatilityofthecountrybondusedtoestimate
thespread.Thisyieldsthefollowingestimateforthecountry
equity risk premium:
Toillustrate,considerthecaseofBrazil.Asnotedearlier,the
dollar-denominatedbondsissuedbytheBraziliangovernment
trade with a default spread of 3.50 percent over the U.S.
Treasurybondrate.Theannualizedstandarddeviationinthe
Brazilianequityindexwas 36 percent,whiletheannualized
standard deviation in the Brazilian dollar-denominated
C-Bond was 27 percent.
20 Theresultingadditionalcountryequityriskpremiumfor
Brazil is:
Note that this country risk premium will increase if the
countryratingdropsoriftherelativevolatilityoftheequity
market increases. It is also in addition to the equity risk