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The Term Structure of Country Risk and Valuation in Emerging Markets

  • Juan Jose Cruces

    (Department of Economics, Universidad de San Andres)

  • Marcos Buscaglia


  • Joaquin Alonso

    (Mercado Abierto S.A.)

Registered author(s):

    Most practitioners add the country risk to the discount rate when valuing projects in Emerging Markets. This practice does not account for the fact that the default risk term structure can be nonflat. The mismatch between the duration of the project under valuation and the duration of the most widely used measure of country risk, 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. Using sovereign bond data from five Emerging Markets, we estimate a simple model that captures most of the variation of conditional default probabilities at different horizons for a given country at one point in time. This model can be used to solve the misestimation problem.

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    File Function: Revised version, 2002
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    Paper provided by Universidad de San Andres, Departamento de Economia in its series Working Papers with number 46.

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    Length: 27 pages
    Date of creation: Jan 2002
    Date of revision: Apr 2002
    Handle: RePEc:sad:wpaper:46
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    1. Neumeyer, Pablo Andrés & Perri, Fabrizio, 2004. "Business Cycles in Emerging Economies: The Role of Interest Rates," CEPR Discussion Papers 4482, C.E.P.R. Discussion Papers.
    2. John J. Merrick Jr., 1999. "Crisis Dynamics of Implied Default Recovery Ratios: Evidence From Russia and Argentina," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-052, New York University, Leonard N. Stern School of Business-.
    3. Chen, Houng-Yhi, 1967. "Valuation Under Uncertainty," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 2(03), pages 313-325, September.
    4. Campbell R. Harvey, 1994. "Predictable Risk and Returns in Emerging Markets," NBER Working Papers 4621, National Bureau of Economic Research, Inc.
    5. Stephen Godfrey & Ramon Espinosa, 1996. "A Practical Approach To Calculating Costs Of Equity For Investments In Emerging Markets," Journal of Applied Corporate Finance, Morgan Stanley, vol. 9(3), pages 80-90.
    6. Errunza, Vihang & Losq, Etienne, 1985. " International Asset Pricing under Mild Segmentation: Theory and Test," Journal of Finance, American Finance Association, vol. 40(1), pages 105-24, March.
    7. Bekaert, Geert & Harvey, Campbell R. & Lumsdaine, Robin L., 2002. "Dating the integration of world equity markets," Journal of Financial Economics, Elsevier, vol. 65(2), pages 203-247, August.
    8. Tom Keck & Eric Levengood & AL Longfield, 1998. "Using Discounted Cash Flow Analysis In An International Setting: A Survey Of Issues In Modeling The Cost Of Capital," Journal of Applied Corporate Finance, Morgan Stanley, vol. 11(3), pages 82-99.
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