A model of asset pricing under country risk

Abstract

Keywords: Sovereign spread Asset pricing Emerging market discount a b s t r a c t 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.

Do Implicit Barriers Matter for Globalization?

“…Implicit barriers such as liquidity and political risk factors have become the focus of recent studies. Bekaert, Harvey, and Lundblad (2007) and Lee (2011) empirically analyze liquidity effects, and Andrade (2009) investigates country risk effects in EMs. Without a formal international asset pricing model that jointly accounts for implicit barriers in conjunction with barriers to portfolio flows, it is not possible to conclude whether factors, such as liquidity and political risks, would systematically impact the integration measure estimated from the EL model.…”

“…Stulz (2005) identifies the twin agency problems related to expropriation by the state and by corporate insiders at the expense of outside investors as the primary hindrance to financial globalization. Bekaert, Harvey, and Lundblad (2007) and Lee (2011) model the impact of liquidity, and Andrade (2009) evaluates country risk effects on pricing of EM assets. While these studies improve our understanding of the importance of implicit barriers in asset valuation, our paper relates the lack of integration to the intensity of such barriers and quantifies the role of institutional, informational, and governance factors for emerging markets.…”

Predictors of Investors’ Participation in the Egyptian Stock Market: Application of Theory of Planned Behavior

“…Political risk, as a source volatility or systematic risk, is considered one of the determinants of market risk premium [34], a major determinant of domestic and foreign investment decisions and a variable that is able to explain disparities of stocks' returns between different countries [35].…”

Sovereign Default Risk and the U.S. Equity Market

“…Both effects constitute the government's motivation for avoiding default. This trade-off between the gains from and the costs of default determines the level of fiscal revenue at which it becomes optimal to default, as noted by Andrade (2009) andJeanneret (2015). …”

“…First, the foundation for the paper is an international consumption-based model with representative risk-averse agents, following Pavlova and Rigobon (2007), Verdelhan (2010), Colacito andCroce (2011), Bansal andShaliastovich (2012), and Gourio, Siemer, and Verdelhan (2013), which I extend by incorporating heterogeneous levered firms and sovereign default risk. The government's decision to default and its consequences for economic activity follow the work of Cohen and Sachs (1986), Bulow and Rogoff (1989), Arellano (2008), Andrade (2009), Hatchondo and Martinez (2009), Yue (2010, Borri andVerdelhan (2012), andJeanneret (2015), among others. The evaluation of firm assets is related to Bhamra et al (2010aBhamra et al ( ), (2010b and Chen (2010), who embed firms with exogenous macroeconomic regimes (Hackbarth, Miao, and Morellec (2006)) in a consumption-based asset pricing model.…”