Country risk premium

Country risks play a central role in business valuations. They include both direct and indirect country risks. Direct country risks refer to potential losses associated with claims against foreign sovereign states. Capital markets reflect these risks through correspondingly higher required rates of return.

Indirect country risks, by contrast, arise when the occurrence of direct country risks, such as a sovereign default, may affect the performance of the company being valued and its future cash flows. Indirect country risks should be included separately as a part of a company's projected future cash flows. If country-specific risks cannot be adequately captured in the projected financial cash flows, they may alternatively be reflected in the discount rate through an additional risk premium on top of the cost of capital estimated under the CAPM framework. 

We estimate country risk premiums based on 5-year Credit Default Swaps (CDS). CDS reflect the sovereign default risk priced by capital markets for individual countries. As CDS spreads rely on data from sovereign bond markets, they need to be adjusted to reflect the higher risk of equity markets. We therefore derive Equity Multipliers. These multipliers are calculated as the ratio of the annualized volatility of representative equity and bond market indices. To capture structural differences across capital markets, the calculation is performed separately for Emerging Markets, Developed Countries (excluding the United States), and the United States. This approach enables a more granular assessment of developed markets outside the U.S. and allows for a precise estimation of European country risk premiums.

The line charts illustrate the development of country risk premiums for selected countries over the past twelve months. The values shown are based on the respective month-end CDS spreads and Equity Multipliers.

Upon request, we are happy to provide you with country risk premiums for additional valuation dates and for 100+ countries.