Are country risks real?

BVWireIssue #170-4
November 30, 2016

That was a question posed at a conference in Atlanta co-sponsored by the Southeast Chapter of Business Appraisers (SECBA) and the International Association of Consultants, Valuators and Analysts (IACVA). Kevin Madden (Duff & Phelps), who conducted a session on cost of capital, pointed to research from Bekaert and Harvey (2014) that states: “Given the dramatic globalization over the past twenty years, does it make sense to segregate global equities into ‘developed’ and ‘emerging’ market buckets? We argue that the answer is still yes.… emerging market assets still have higher risk than most developed markets—and as a result, continue to command higher expected returns.”

What to do: It’s difficult to incorporate country risk into cash flows because there’s typically a lack of reliable data. That means you need to adjust the discount rate. It is no longer acceptable to add an ad hoc country risk premium to the discount rate. Several international cost of capital models are available, but it can be challenging for practitioners to find the appropriate underlying inputs. Plus, there is no consensus among academics and practitioners as to the “best” model to use. When choosing a model, the goal is to balance several objectives: acceptance and use, data availability, and simplicity.

For more guidance, the CFA Institute will present a webinar, Quantifying Country Risk Premiums, on December 6 from 1:00 p.m. to 2:00 p.m. EST. The presenters will be James P. Harrington and Carla Nunes, who are both with Duff & Phelps. You can register for the webinar if you click here.

Harrington and Nunes are co-authors (with Roger Grabowski) of the 2016 International Valuation Handbook - Guide to Cost of Capital, which provides country-level country risk premia, relative volatility factors, and equity risk premia that can be used to estimate country-level cost of equity capital globally, for up to 188 countries, from the perspective of investors based in up to 55 countries. A companion guide is the 2016 International Valuation Handbook - Industry Cost of Capital, which provides industry-level cost of capital estimates.

Please let us know if you have any comments about this article or enhancements you would like to see.