A model of asset pricing under country risk

I develop a formal model that could provide quantitative guidance to practitioners who use sovereign yield spreads in emerging market asset valuation. The model provides analytical formulas relating emerging market stock P/E ratios (and expected returns) to the corresponding average yield spread in...

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Published in:Journal of international money and finance 2009-06, Vol.28 (4), p.671-695
Main Author: Andrade, Sandro C.
Format: Article
Language:English
Subjects:
Asset pricing
Capital returns
Emerging market discount
Emerging markets
International finance
Political instability
Political risk
Risk management
Sovereign spread
Sovereign spread Asset pricing Emerging market discount
Spread
Studies
Yield
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description I develop a formal model that could provide quantitative guidance to practitioners who use sovereign yield spreads in emerging market asset valuation. The model provides analytical formulas relating emerging market stock P/E ratios (and expected returns) to the corresponding average yield spread in sovereign bonds. In the model, sovereign yield spreads carry information about the likelihood of a negative regime change in an emerging market (“country risk”), under the common assumption that the regime change is associated with a hostile renegotiation of the country's foreign debt. In the model, country risk is priced because the regime change may be endogenously associated with bad states of the global economy. Data from emerging markets are consistent with some of the model's quantitative and qualitative predictions.
doi_str_mv 10.1016/j.jimonfin.2008.12.014
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source International Bibliography of the Social Sciences (IBSS); Elsevier
subjects Asset pricing
Capital returns
Emerging market discount
Emerging markets
International finance
Political instability
Political risk
Risk management
Sovereign spread
Sovereign spread Asset pricing Emerging market discount
Spread
Studies
Yield
title A model of asset pricing under country risk
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