Accounting for Sovereign Risk When Investing in Emerging Markets

11 Pages Posted: 12 Jul 2011

See all articles by V. Ravi Anshuman

V. Ravi Anshuman

affiliation not provided to SSRN

John Martin

Baylor University

Sheridan Titman

University of Texas at Austin - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: Spring 2011

Abstract

In theory, political risk is project‐specific and should be accounted for in the estimation of the expected investment cash flows. But in practice, the political risk associated with this type of investment is typically accounted for implicitly by adjusting the investment's required rate of return or the discount rate. As the authors discuss in the article, this approach disguises the specific assumptions being made about the risk of expropriation and so makes it difficult to assess this risk properly. While defending some aspects of current practice, the authors argue that corporate executives should consider some changes. For example, although a project analysis that is shared with the host government could incorporate a risk adjustment to the discount rate, the authors suggest that more explicit analysis of the anticipated risk of expropriation should be incorporated into the analysis of expected project cash flows. This analysis could involve making specific assumptions about the “term structure” of expropriation risk over the life of the investment. Finally, the authors note that the political risk of making investments in emerging economies can be managed to some extent. Investments can be structured in ways that reduce political risk by structuring project cash flows in ways that better align the incentives of the project sponsor and the government of the host country.

Suggested Citation

Anshuman, V. Ravi and Martin, John and Titman, Sheridan, Accounting for Sovereign Risk When Investing in Emerging Markets (Spring 2011). Journal of Applied Corporate Finance, Vol. 23, Issue 2, pp. 41-49, 2011. Available at SSRN: https://ssrn.com/abstract=1884029 or http://dx.doi.org/10.1111/j.1745-6622.2011.00325.x

V. Ravi Anshuman (Contact Author)

affiliation not provided to SSRN

John Martin

Baylor University

Waco, TX 76798
United States

Sheridan Titman

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-232-2787 (Phone)
512-471-5073 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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