A model of asset pricing under country risk

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Abstract

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.

Original languageEnglish (US)
Pages (from-to)671-695
Number of pages25
JournalJournal of International Money and Finance
Volume28
Issue number4
DOIs
StatePublished - Jun 1 2009

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Keywords

  • Asset pricing
  • Emerging market discount
  • Sovereign spread

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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