Country Risk Premium
The additional return investors require to compensate for the incremental risks of investing in a foreign country versus a risk-free benchmark.
What is Country Risk Premium?
A country risk premium (CRP) is the additional expected return that investors demand to compensate for the risks associated with investing in a particular country compared to a baseline risk-free investment. These incremental risks include political instability, currency volatility, economic uncertainty, weak rule of law, expropriation risk, and sovereign default risk. The CRP is added to the cost of equity when valuing companies in emerging or frontier markets using the CAPM or discounted cash flow framework: Cost of Equity = Risk-Free Rate + Beta × Equity Risk Premium + CRP. Damodaran's widely cited approach estimates CRP from the country's sovereign credit default swap spread or from the difference between the country's bond yield and the US Treasury yield of similar maturity, scaled by the relative volatility of equities to bonds. Higher CRP implies a higher discount rate and lower equity valuations for companies in that country.
Example
A Brazilian company is valued using DCF. The analyst uses a US risk-free rate of 4.5%, a US equity risk premium of 5%, a company beta of 1.1, and estimates Brazil's CRP at 3.5% based on its sovereign spread. The cost of equity becomes 4.5% + (1.1 × 5%) + 3.5% = 13.5% — significantly higher than a US peer would require, reflecting Brazil's additional political and currency risk.