COUNTRY RISK UPDATE: JANUARY 2018 DATA UPDATE 5

Aswath Damodaran

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The Set Up

¨ There is more risk in investing in some countries than others. It follows that the price of taking equity risk, i.e., the equity risk premium will vary across countries.

¨ A company’s risk exposure comes from where it does business, not just where it is incorporated and traded.

¨ As globalization becomes the norm, not the exception, even purely domestic investors have to think about country risk.

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Sovereign Default Risk Measure 1: Sovereign Ratings

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Sovereign Default Risk Measure 2: Sovereign CDS Spreads

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Equity Risk Measure 1: Risk Scores

¨ The World Bank, Political Risk Services (PRS) and the Economist, among others, try to measure the total risk in countries.

¨ Those scores have no standardization and cannot be compared, but they still represent more comprehensive measures of risk than sovereign ratings or CDS spreads.

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PRS Scores

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Equity Risk Premiums

Aswath Damodaran

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ERP – A Global Picture

Black #: Total ERPRed #: Country risk premiumRegional #: GDP weighted average

ERP

: Jan

201

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From Country to Company Risk

¨ A company's risk does not come from where it is incorporated, but where it does business.

¨ If we adopt this perspective, it is clear that to value a company, you need to see its risk exposure to different countries, either because it has its production and operations in those countries or because it sells its products or services there.

¨ That risk exposure, in conjunction with the equity risk premiums of the countries estimated in the earlier section, can be used to compute the company's equity risk premium.

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Implications

¨ A company cannot change its risk profile by delisting in one market and re-listing in another: It is a common play for emerging market companies to delist on their "risky" local markets and to re-list on a more developed markets.

¨ A company's equity risk premium should change, as its geographic exposure changes: In estimating the equity risk premium for a company today, we need to consider where it operates today.

¨ When multinationals assess projects, their hurdle rates should vary across geographies: When multinationals assess hurdle rates for projects, those hurdle rates should vary, depending upon where a project will be, even if the hurdle rates are estimated in the same currency.

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In conclusion..

¨ If, as the Chinese symbol for crisis suggests, Danger + Opportunity = Risk, it is not surprising that the most risky parts of the world also provide the most potential for growth.

¨ By demanding higher equity risk premiums for investing in these parts of the world, I am not suggesting that you hold back from investing but only that you demand enough of a premium for exposing yourself to additional risk.

¨ After all, investing is never be bungee jumping, taking risk for the sake of taking risk.