Country Risk Premium

Investing in some countries carries risks beyond those of the company itself. Governments might change laws suddenly, expropriate assets, impose capital controls or default on their debts. Economies may be more volatile, and currencies may fall sharply.

In valuation, analysts often add a country risk premium to the cost of equity for businesses operating in riskier countries. For example, if a company's cost of equity would be 9% in a stable developed market, an analyst might add a country risk premium of 3% for operations in a higher-risk emerging market, giving 12%.

Country risk premiums are often estimated from the extra yield on a country's government bonds compared with a safe benchmark, from credit default swap spreads or from sovereign credit ratings, sometimes adjusted for the greater volatility of shares compared with bonds.

How to apply country risk is debated. Some argue it should depend on how much of a company's revenue and assets are exposed to the country, rather than where the company is headquartered. Others prefer adjusting cash flows for specific risks instead of the discount rate.