Beyond Sovereign Risk: A Frontier Market Valuation Model (FMVM) for Contextualizing Equity Cost in Structurally Constrained Markets

This study introduces the frontier market valuation model (FMVM), a novel and exploratory framework designed to more accurately estimate the cost of equity in structurally constrained markets. Traditional models such as CAPM and Damodaran's country risk premium (CRP) fail to capture the layered risks prevalent in frontier economies. FMVM addresses this gap by integrating four explicit premiums: sovereign risk, liquidity constraints, behavioral volatility, and institutional quality deficits. The aim is to develop a context-sensitive model that better reflects equity risk in frontier and transitioning markets. Using empirical data from five countries-Croatia, Serbia, Bosnia and Herzegovina, Turkey, and Hungary-the model is calibrated and applied in an attempt to assess its robustness and explanatory power. Croatia serves as the primary case study, with data spanning a 15-year period, offering a detailed benchmark for model validation. The findings show that FMVM consistently yields higher and more differentiated discount rates than traditional models, particularly in markets with severe illiquidity, governance deficits, or sentiment-driven volatility. FMVM provides theoretical advancement and practical utility by quantifying unpriced structural risks and guiding reforms aimed at reducing capital costs.