Country Risk Premium - CRP

Following the 2008 financial crisis, every major developed economy exploded their balance sheet and dramatically increased their debt load. Then, a decade later, a lot of those bills came due. As a result, many countries from Mexico to Italy, from Brazil to Greece, have seen their debt problems hammer their currency values and drive up borrowing costs.

Investors have a lot of choices of what countries’ bonds to purchase and what foreign stocks to buy. With bonds, countries with a higher risk of default will naturally see interest rates rise, since lenders want a greater return for the risks they are taking as bond buyers in those countries.

With individual equities, companies in foreign countries are subject to political risk and broader economic uncertainty compared to firms in more developed, stable markets.

Risk premiums for bonds are defined by the spread between one nation’s interest rates and the interest rates for the less development nation’s bonds.

But on the individual equity side, investors need to utilize CAPM and add the country risk premium of one foreign stock compared to a stock from a more stable economy. CAPM has its flaws. But if you’re going to learn the industry standard, you might as well know how capital risk premiums are traditinoally calculated using that model.