Session 4: Risk free Rates (continued) and first steps on ERP
We started the class by completing the discussion of risk free rates, exploring why risk free rates vary across currencies and what to do about really low or negative risk free rates. The blog post below captures my thoughts on negative risk free rates:
http://aswathdamodaran.blogspot.com/2016/03/negative-interest-rates-unreal.html
We are about halfway through the discussion of equity risk premiums but the contours of the discussion should be clear.
a. Historical equity risk premiums are not only backward looking but are noisy (have high standard errors). You can the historical return data for the US on my website by going to
http://www.stern.nyu.edu/~adamodar/New_Home_Page/data.html
Click on current data, and look to the top of the table of downloadable data items.
b. Country risk premium: The last few months should be a reminder of why country risk is not diversifiable. As you see markets are volatile around the world, I think you have a rationale for a country risk premium. You can get default spreads for country bonds on my site under updated data. If you are interested in assessing and measuring country risk, to get from default spreads to equity risk premiums, you need two more numbers. The first is the standard deviation for the equity market in the country that you are trying to estimate the premium for. Try the Bloomberg terminal. Find the equity index for the country in question (Bovespa for Brazil, Merval for Argentina etc.) and type in HVT. This should give you the annualized standard deviation in the index - change the default to weekly and use the 100-week standard deviation. Do the same for the country bond in question. The two standard deviations should yield the relative volatility. If you have trouble finding either number, just multiply the default spread by 1.4 to get a rough measure of the country risk premium. If you want my estimates of country risk premiums, check under updated data on my website. The direct link is below:
http://www.stern.nyu.edu/~adamodar/pc/datasets/ctryprem.xls
You can also see my latest blog post on country risk here:
http://aswathdamodaran.blogspot.com/2017/01/january-2017-data-update-4-country-risk.html
Start of the class test: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/tests/riskfree.pdf
Slides: http://www.stern.nyu.edu/~adamodar/podcasts/valUGspr17/session4.pdf
Post class test: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session4test.pdf
Post class test solution: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session4soln.pdf
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🎥 Mini series about business & money.
💸 Business is fascinating. The way empires are built and destroyed... Fortunes are made and lost... And companies battle to change the world. A 'magnate' just means a very wealthy and influential businessperson - and we'll be covering the stories of many different magnates here on this channel.
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Aswath Damodaran
