The Term Structure of Country Risk and Valuation in Emerging Markets

32 Pages Posted: 30 Sep 2002

See all articles by Juan J. Cruces

Juan J. Cruces

University of San Andres (UMSA) - Department of Economics

Marcos Buscaglia

University of San Andres (UMSA)

Joaquin Alonso

Mercado Abiero

Date Written: August 12, 2002

Abstract

The prevailing valuation technique in Emerging Markets adds the country risk to the discount rate in an ad-hoc manner. This practice does not account for the term structure of default risk. The mismatch between the duration of the project being valued and the duration of the measure of country risk used, such as J.P. Morgan's EMBI, leads to an overvaluation (undervaluation) of long-term projects when the term structure of default risk is upward (downward) sloping. Even if the term structure of default risk were flat, this practice implies attenuating the covariance risk premium. Using sovereign bond data from five Emerging Markets, we estimate a model that captures most of the variation of expected collection at different horizons at one point in time. We show the mispricing errors that are likely to be incurred in practice and how our model can be used to avoid them.

Keywords: Emerging Economies, Cost of Capital, Default Risk

JEL Classification: G15, G31

Suggested Citation

Cruces, Juan José and Buscaglia, Marcos and Alonso, Joaquin, The Term Structure of Country Risk and Valuation in Emerging Markets (August 12, 2002). Available at SSRN: https://ssrn.com/abstract=327301 or http://dx.doi.org/10.2139/ssrn.327301

Juan José Cruces

University of San Andres (UMSA) - Department of Economics ( email )

Vito Dumas 284
B1644BID Victoria, Buenos Aires
Argentina
+5411 4725 7088 (Phone)
+5411 4725 7027 (Fax)

Marcos Buscaglia (Contact Author)

University of San Andres (UMSA) ( email )

Vita Dumas 284
(1644) Victoria, Pcia
Buenos Aires, Buenos Aires 1644
Argentina

Joaquin Alonso

Mercado Abiero ( email )

Buenos Aires
Argentina

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