how would you estimate E?RP for countries without stock markets such as the Seychelles?
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First, if the hypothetical stock market has a bond market you could look at the yield spread between government yields and treasury bonds (or another international risk free rate, such as, German bunds), and add the yield spread to a the equity risk premium. For example, if the hypothetical country has a yield spread of 5% relative to 20 year treasury bonds, you could add this yield spread to the equity risk premium of approximately 4.5% to derive a country specific equity risk premium of 4.5%. Alternatively, you could look at the equity risk premium for emerging or new emerging economies that do have equity markets. The equity risk premiums in those markets could function as a proxy for your hypothetical market. An alternative approach would be to build up the rate for various sources of risk. For example, you could stipulate the following formula:
Risk Premium for Country X = Normal Risk Premium + Small Size Premium +/- Value Premium/Growth Premium + Liquidity Premium + Country Specific Premium
In this approach, you would first identify a normal risk premium for a development economy, say, Europe. Then, if the market capitalization of companies in the new economy is expected to be small, you could add a small size premium. To proxy the small size premium, you could examine the small size premium demanded in the U.S, Europe, and Emerging Economics. If the country market was also expected to be population with value companies you could add a premium for value stocks, or alternatively reduce the premium if the new stock market was expected to be populated with growth stocks. You could proxy this premium in a similar fashion as that for estimating the value premium. If the market is expected to be illiquid (which is likely for a new stock market) then a liquidity premium could be added. This could be estimated in several ways. For example, compare the yield spreads of very illiquid debt to liquid debt of similar maturities. Use an option pricing model to proxy for illiquidity, etc. Finally, add a subjective country specific risk premium for other factors, say, 2-5%.
Correct: 5% + 4.5% = 9.5% country specific risk premium
You can find it following this link:http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html
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No,sorry Seychelles is apsence in this page...
Thanks Valuator and Sevak. Very helpful. I have consulted the Damodaran pages also, but obviously, many "exotic" countries are not there. Unfortunately, for many natural resources assets and projects, exotics are the norm.