A Model of Asset Pricing under Country Risk

49 Pages Posted: 17 Mar 2008 Last revised: 29 Jan 2009

See all articles by Sandro C. Andrade

Sandro C. Andrade

University of Miami - Department of Finance

Date Written: October 1, 2008

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 closed-form 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.

Keywords: sovereign spread, asset pricing, emerging market discount

JEL Classification: F21, F34, G12, G15

Suggested Citation

Andrade, Sandro C., A Model of Asset Pricing under Country Risk (October 1, 2008). Journal of International Money and Finance, Vol. 28, No. 3, 2009. Available at SSRN: https://ssrn.com/abstract=1105485 or http://dx.doi.org/10.2139/ssrn.1105485

Sandro C. Andrade (Contact Author)

University of Miami - Department of Finance ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States

HOME PAGE: http://moya.bus.miami.edu/~sandrade/

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