Monday, September 16, 2013

The Equity Risk Premium In Emerging Markets



Back for his second appearance as our guest blogger is Dr. Aswath Damodaran from the Stern School at NYU. Dr. Damodaran is a noted expert on valuation and publishes his own blog, Musings on Markets.  Here, he discusses the equity risk premium in emerging markets, a shortened version of his more detailed post. If you are interested in more on the U.S equity, check out Dr. Damodaran’s updated article on the U.S. equity risk premium.

As you have figured out from the textbook, estimating the U.S equity risk premium (ERP) is not a simple task. Things get even more complicated when we are attempting to estimate the ERP in emerging markets. In a recent discussion, Dr. Damodaran examines the factors that affect the ERP in emerging markets. The first factor is the sovereign credit rating and credit default spreads. A country with a higher probability of default on sovereign debt is more risky, and therefore would have a higher ERP as financial instability in the government would extend to the private market as well. Next is the country risk score, which measures economic, political, and legal risks in the country. Finally, the volatility of the individual country’s equity market as measured by standard deviation impacts the ERP. Using this method, Guinea, Sudan, Somolia, and Zimbabwe share the highest ERP, at 22.25 percent. In contrast, the ERP for the U.S is 5.75 percent.