Week 2: Estimating Country Risk Premium
are trying to estimate the country risk premium that you would apply to China.
You have collected the following information:
- China is rated A3 by Moody’s. The typical default spread
for A3 rated bonds is 95 basis points.
- There are no dollar denominated Chinese bonds
outstanding, but the government bond in CY bears an interest rate of 11.15%.
Over the last two years, the standard deviation in this bond has been 17.3%.
- The Chinese equity index has had an annualized standard
deviation of 31.1% over the last 2 years.
- The U.S. treasury bond rate is 5%, the historical risk
premium of stocks over T.bonds over the last 73 years in the U.S. has been
5.17% and the annualized standard deviation in U.S. equities has been 24.6%.
Estimate the country premium for China and the total risk premium for equities
a. Pure bond default spread approach
b. Relative equity market volatility
c. Market volatility adjusted default spread.