Importance, determinants, and ways of estimating the equity risk premium

• The paper "Equity Risk Premiums (ERP)- Determinants, Estimation, and Implications - The 2024 Edition" explores the importance, determinants, and ways of estimating the equity risk premium, which is crucial in corporate finance and valuation.
• It delves into the relationship between the equity risk premium and bond market default spreads and real estate cap rates, and explains why various approaches may yield varying values for the equity risk premium.
• The paper also discusses the survivor bias, small cap and other risk premiums, and country risk premiums.
• It delves into option pricing models and equity risk premia, and explores the importance of understanding the equity risk premium, which represents the additional return required by investors to compensate them for the risk associated with investing in equities compared to safer investments like government bonds.
• It also explores the relationship between the equity risk premium and bond market default spreads and real estate cap rates.
• The paper also explores asset prices and business cycles with liquidity risk, income inequality impacts on the concave absolute risk tolerance, leading to potentially higher equity risk premiums, and the relationship between inflation rates and equity risk premia.
• It also explores the concept of earnings quality defined in terms of the volatility of returns.

The equity risk premium puzzle remains unsolved

• The paper discusses the equity risk premium puzzle and explores various theories that aim to explain why the observed premium is significantly higher than what would be predicted by models of rational investor behavior.
• The author also highlights some potential issues with using historical risk premiums for valuation purposes, suggesting that additional premiums may need to be considered for riskier markets or stock classes.

Implied equity risk premia offer some advantages over historical premia

• The cash flows need to be put through a similar risk adjustment process as the discount rates.
• The main downside of using historical equity risk premia is that they are backward-looking, static, and noisy.
• Implied equity risk premia offer some advantages over historical premia.
• Even though period-specific equity risk premiums might be computable, the impact on asset value when using them instead of the compounded average premium is typically small in most assessments.
• The direct relevance of these discussions to valuation and corporate finance practices remains uncertain.
• Market timers often use technical indicators, like moving averages and momentum measures, to judge market direction.
• This could imply that instead of assuming that the risk premium remains constant regardless of inflation and interest rates levels, it might be more practical to increase the risk premium when anticipated inflation and interest rates rise.
• The correlation matrix of implied equity risk premiums with macroeconomic variables, like real GDP growth, inflation and exchange rate, is negative for GDP growth and positive for inflation.
• Market timers often use technical indicators, like moving averages and momentum measures, to judge market direction.
• Another method is comparing the current implied premium to the average historical premium within a particular sector, assuming that the value will return to the historical average eventually.
• Between 2005 and 2007, the implied equity risk premium for commercial banking stocks was approximately 4%, suggesting that these stocks were undervalued in September 2008.
• However, the market reflected the unique risks faced by financial service companies during that period, possibly implying a higher perceived risk associated with these stocks.
• An alternative approach to valuing illiquid assets is to adjust the discount rate upwards instead of applying an illiquidity discount.
• Another factor is differing views on market efficiency; some analysts believe that markets can be significantly overvalued or undervalued, influencing their preferred method of risk premium calculation.
• Additionally, the purpose of the analysis may also impact the chosen method of measurement.

The availability and quality of information affect perceived investment risks and returns, leading to varying equity risk premiums across markets.

• Investing in equities involves taking on the same risks as the broader economy.
• Over the last two decades, the availability and quality of information have changed significantly, affecting perceptions of investment risks and returns.
• Lower equity risk premiums were seen during the market boom in the late 1990s, potentially due to increased investor confidence resulting from improved information.
• Higher equity risk premiums result in higher investment costs, leading to decreased overall investment in the economy and slower economic growth.
• The discussion surrounding equity risk premiums often involves debates between analysts working for utility companies seeking higher premiums, and regulators favoring lower ones.
• Better information should theoretically lead to lower premiums, but this depends on the accuracy of that information in predicting future earnings and cash flow.
• Changes in technology, accounting practices, auditing standards, and financial forecasting have all contributed to a decline in the quality of earnings.
• If earnings are less informative, it stands to reason that investors would demand higher equity risk premiums to compensate for the additional uncertainty.
• Information differences may account for varying equity risk premiums across different markets.
• The argument that the market for publicly traded stocks is broad and deep, leading to a small net effect of illiquidity on aggregate equity risk premiums, may be dubious due to variations in liquidity across stocks and the impact this has on trading costs.
• Hurdle rates used by companies, based on equity and capital costs, are affected by the equity risk premiums they employ, influencing investment, financing, and dividend decisions.
• Despite concerns about the performance of the Capital Asset Pricing Model (CAPM), abandoning this approach is challenging due to the noise associated with historical risk premium estimates.
• Studies have raised doubts about the accuracy of the CAPM, particularly for specific types of stocks.
• Some practitioners adjust their required returns and costs of equity for these kinds of stocks by incorporating an additional premium.
• If CAPM betas and other risk measures in conventional risk and return models underestimate the actual risk of small cap stocks, possible solutions include enhancing the model to account for unrecognized risk, possibly incorporating factors for liquidity issues and informational disadvantages.
• However, it should be noted that the statistical significance of the small firm premium is primarily derived from pre-1981 data, raising questions about the reliability of these trends over more recent decades.
• Relying on small cap premiums to address the limitations of the CAPM could lead to substantial estimation errors due to the high standard deviation of estimates.

Double-counting illiquidity effects can distort the estimation of standard errors in small cap investments, leading to misguided portfolio management decisions.

• The article discusses the impact of small cap premiums on the estimation of standard errors in small cap investments, emphasizing the importance of consistent adjustments when estimating long-term forecasts.
• The author argues against double-counting illiquidity effects and proposes extending the methodology to estimate other variables.
• Different approaches to estimating equity risk premiums are explored, and a pathway is suggested for choosing the best number for analysis.
• The author highlights the range of values obtained using different methods and stresses the importance of recognizing rapid changes in premiums following major events.
• The article also emphasizes the dangers of using a uniform equity risk premium across all stocks, which can lead to systematic errors in valuation and misguided portfolio management decisions.

There is significant variation in estimated equity risk premia due to various survey methods and subjective responses, leading to uncertainty regarding the true level of the premium.

• These surveys often capture shifts in sentiments rather than strictly estimating equity risk premiums.
• The results show variations in expected real returns of individual investors globally, as well as differences between individual and professional investors.
• Merrill Lynch's monthly survey of institutional investors globally explicitly asks about equity risk premiums, reporting average premiums ranging from 3.5% to 4.1%.
• The American Association of Individual Investors (AAII) conducts weekly surveys measuring sentiment shifts among investors.
• These survey risk premiums tend to respond to recent trends in stock prices, typically rising following periods of market growth and falling after market declines.
• High points in the survey premiums of individual investors were seen during the 1999 bull market, with less extreme premiums occurring in 2003 and 2004 following the market collapses of 2000 and 2001.
• Male advisors, in particular, tend to provide lower estimates compared to female advisors.
• Over time, the average equity risk premium fluctuates, ranging from 3.37% in 2016 to 4.42% in 2018.
• These fluctuations, along with the variability within the sample of advisors, contribute to uncertainty about the precise level of the equity risk premium.
• However, the standard deviation in both annual stock returns and the risk premium itself suggest that the equity risk premium typically falls between 19.55% and 20.99%.
• Using these figures and a formula involving the current index value, the authors calculate an implied equity risk premium for both small cap stocks and the overall market.
• The small cap premium is calculated as the difference between these two risk premia.
• The VIX, or volatility index, measures 30-day expected volatility derived from the implied volatilities in traded S&P 500 index options.
• Graham and Harvey's CFO survey premium discovered a positive correlation between CFO-demanded premiums and the VIX value, although this correlation has lessened over time.
• Therefore, the cost of equity for an Indonesian corporation, calculated in US dollars, would be 2.07% higher compared to an identical U.S.
• corporation, using the January 2024 estimation of the default spread.
• Equity risk is measured by the standard deviation in stock prices, with higher standard deviations signaling more risk.
• To compare the risk of one market to another, a relative standard deviation can be calculated.
• The CAPM measures this risk with a beta coefficient multiplied by the equity risk premium, while the APM and multi-factor models estimate betas against individual risk factors, each with its own risk premium.
• Proxy models use firm characteristics instead of direct risk premium computations; however, the coefficients on these proxies still reflect risk preferences.
• The source also mentions four groups of models and the roles equity risk premiums play in each one, summarized in a table.
• The formula for expected return is given as Riskfree Rate plus b j j=1 j= k (Risk Premiumj).
• All models except proxy models require three inputs.
• Amounts set aside by both corporations and governments for future obligations are based on their views on equity risk premium, influencing how much they need to set aside annually to meet future commitments.
• If the equity risk premium assumed is low but actual performance is poor, it can result in shortfalls, necessitating tax increases or profit reductions for corporations.
• One potential solution, proposed by Reitz, suggests that investments with dividends directly tied to consumption (like stocks) should yield significantly greater returns compared to riskless investments in order to offset the likelihood of substantial drops in consumption.
• Prescott and Mehra argue that the required drops in consumption would have to be of such a large magnitude to explain observed premiums that this solution is not viable.
• Despite the impact of inflation on stock returns, resulting in a decrease over time, it doesn't significantly affect real equity risk premiums.
• The article discusses the difference between pre-tax and post-tax equity risk premiums in terms of whether they should be applied before or after corporate and personal taxes.

Equity risk premium can be calculated using dividends or earnings yield, assuming stable growth and long-term excess returns.

• The article discusses the use of dividends, dividend discount models (DDM), and earnings yield approaches to calculate the equity risk premium.
• It explains how dividends, anticipated dividends, and forecasted long-term growth rates are used as inputs in a DDM.
• The equity risk premium can be calculated using either the dividend discount model or the earnings yield approach, both relying heavily on the assumption of stable growth and long-term excess returns.
• The authors mention potential corrections to the dividend discount model, such as considering potential dividends rather than actual ones and adjusting for tax disparities between dividends and capital gains.
• The article also highlights challenges in estimating future earnings, valuing pass-through entities, and dealing with differing tax treatments for dividends and capital gains.

Estimating long-term equity returns is important for investors and requires considering factors such as dividends, earnings, and growth prospects.

• The article discusses the methodology behind estimating long-term equity returns.
• It explains how the dividend yield, earnings yield, and expected growth can be used to calculate the required return on equity, given a certain risk-free rate.
• The author argues that analysts' forecasts of earnings growth are relatively accurate and that buybacks, which can be volatile, might have reached a peak in 2007.
• The dividend yield and the earnings yield, when combined with certain growth or return assumptions, can act as proxies for the equity risk premium.
• The study also examines the perceived higher equity risk premium attached to commercial bank stocks following several high-profile banking sector failures in September 2008 and suggests that it would be more accurate to estimate betas for technology companies against a tech-focused index, rather than the overall market index.

There is ongoing debate about the best method for estimating the equity risk premium, with various factors influencing the accuracy of the estimates.

• The authors examine how to calculate the expected returns of companies listed in the S&P 600 Index, taking into account various factors such as earnings growth rates, cash payout ratios, and dividends plus buybacks.
• Historically, the stock market risk premium was calculated based on data from 1792 to 1925, resulting in a 3.76% risk premium on an arithmetic average basis and 2.83% on a geometric average basis.
• However, these historical calculations may not accurately represent today's markets, due to the unusual behavior of the U.S.
• equity market in the 1870s, which exhibited characteristics more similar to an emerging market than a mature one.
• To overcome this issue, some propose estimating the risk premium by comparing the expected return on stocks to a risk-free security, such as short-term government securities like treasury bills.
• Others argue that long-term treasury bonds are more reliable due to their consistent upward-sloping yield curve in the U.S.
• over the past eight decades.
• Choosing the appropriate risk-free rate is critical for accurately calculating the equity risk premium.
• Additionally, selecting the right historical period and method for averaging returns can impact the resulting premium estimate.
• The author highlights the volatility of these numbers, particularly for shorter-term premiums, showing a significant jump in ten-year risk premiums from 2018 to 2019.
• This fluctuation is attributed to the shift in the base year used for calculation, moving from a pre-financial crisis year to a post-financial crisis year when stock values were substantially lower.
• An alternative method for calculating the implied equity risk premium is discussed, which involves adjusting expected returns for changes in stock prices and the long-term risk-free rate, such as the ten-year treasury bond rate.
• Increases in base-year earnings, assuming all other factors remain constant, can lead to a higher implied equity risk premium.

Implied equity premiums have been substantially higher than the arithmetic average premium over much of the past fifty years, except for certain years.

• Equity risk premiums have shown variations in recent decades and have been influenced by factors such as inflation and economic stability.
• Implied equity premiums have been substantially higher than the arithmetic average premium over much of the past fifty years, except for certain years.
• It is suggested that proponents of using historical averages argue that day-to-day volatility in market risk premiums supports the stability of these averages, but others argue that shorter time frames can result in larger standard errors.
• The study concludes that despite central banks' efforts to lower interest rates and potentially boost real investment, persistent expected returns on equities imply that hurdle rates for investments remain stable, suggesting that the Fed's plan to encourage businesses to invest more has not been successful.
• An alternative approach to estimate premiums involves adjusting the payout ratio linearly over the next five years.

The standard error of stock returns might be underestimated due to unrealistic assumptions of uncorrelated annual returns over time.

• The source discusses a research paper on the estimation of the standard error of stock returns, focusing on the equity risk premium, which refers to the additional return above a risk-free asset such as a treasury bond.
• The author suggests that the standard error might be underestimated due to assumptions of uncorrelated annual returns over time.
• Empirical evidence suggests that returns are correlated over time, which would increase the standard error estimate.
• Time-weighted measures of risk premiums, including an extreme form called "constant growth" pricing, are discussed.
• The author argues that the best approach would involve using a broad market-weighted stock index without survivor bias.
• However, empirical studies suggest negative correlation of returns over time.
• The source includes raw data on returns in an appendix, as well as tables presenting summary statistics for stock, 3-month Treasury bill, and ten-year Treasury bond returns from 1928 to 2023.
• Despite the higher returns offered by equities compared to treasuries over this period, there is increased risk due to the larger standard deviations and extreme values seen in the data.
• The 2024 update of the global geometric average equity risk premium reported by Dimson, Marsh and Staunton is 5%, which is below the 6% return seen in the US between 1900 and 2023.

Equity risk premia exhibit volatility from 2010-2022, fluctuating between 4.5% and 6.5%.

• Historical risk premiums cannot be effectively decomposed and removals don't solve inherent problems.
• Estimates exist, including Kroll's 25 size classifications, but the most comprehensive available data span 1927-2023.
• Long-term S&P 500 growth is anticipated at 2.21%, matching overall economic growth.
• Equity risk premia exhibit volatility from 2010-2022, fluctuating between 4.5% and 6.5%.
• Value is derived from cash flow rather than earnings, with companies returning between 60% and 100% of earnings to shareholders.
• Technical indicators, such as moving averages, momentum, and trading volume, can predict stock returns better than purely macroeconomic or fundamental indicators.
• Using historical average returns as a predictor of future stock performance may lead to inaccurate predictions compared to alternative models like dividend dynamics learning and expected stock returns.
• Implied equity risk premia data are collected from the Center for Research in Security Prices (CRSP), covering the period 1928-2022 and presenting monthly and annual returns data.
• Country-specific risk adjustments can assist in gauging potential risks and returns when investing internationally.
• Real assets like real estate may become more attractive investments if the risk premiums of traditional financial assets appear too low.
• The Lettau, Ludvigson, and Wachter (2008) study links the shifting equity risk premiums in the U.S.
• to the fluctuating levels of volatility in the actual economy.

The study suggests that economic stability is crucial in determining the level of the equity risk premium.

• The paper argues that the lower equity risk premiums of the 1990s can be attributed to lessened instability in real economic variables such as employment, consumption, and GDP growth.
• The authors use graphical representations to illustrate the correlation between volatility in GDP growth and the equity risk premium.
• The equity risk premium is affected by catastrophic risks, such as economic depressions and government default on borrowing.
• The Barro-Rietz model has been extended to account for variable loss rates in disasters.
• The impact on equity risk premiums depends on investor utility functions.
• The study investigates asset pricing implications and concludes that the impact on equity risk premiums depends on investor utility functions.
• Using data from 1870 to 2007, they identify 87 crises with an average impact on stock prices of approximately 22%.
• It takes an estimated 7% equity risk premium to compensate for the risk taken.
• The authors build a consumption model where consumption follows a normal distribution with low volatility most of the time, but with a time-varying probability of disasters.
• Another model estimates a likelihood of rare events and long run risks using long term consumption data for 42 countries, suggesting that much of the movement in equity risk premiums comes from changes in the perceived likelihood of rare events.
• In a series of papers, various authors use the variance risk premium, the difference between implied variance in stock market options and realized variance, as a proxy for expectations of catastrophic risk.
• They document a positive correlation between this type of risk and equity risk premiums.
• Another study breaks down jumps into bad (negative) and good (positive), finding that it's the risk of downside jumps that determines equity risk premiums.
• The literature on extreme events, particularly those related to financial market crises, has grown rapidly since the early 1990s.
• Some notable works in this field are those by Black et al.
• Government policies and politics were previously thought not to significantly impact equity risk premiums in developed markets, however, the banking crisis of 2008 and subsequent government responses suggest otherwise.
• Uncertainty around government policy is argued to lead to higher equity risk premiums, particularly immediately after economic downturns when policy changes become more likely.
• The first study to investigate the impact of policy uncertainty on stock markets finds that, on average, stock prices decrease following policy changes, with the size of the negative return increasing when the policy change causes greater uncertainty.
• Furthermore, policy changes lead to increased stock market volatility and stronger correlations between individual stocks.
• A measure of economic policy uncertainty (EPU) created by Baker et al (2016) is utilized in various papers to examine this phenomenon.
• Lam, Zhang and Zhang (2020) attempt to quantify potential policy shocks stemming from either an unstable government or an ineffective bureaucracy in 49 countries from 1995 to 2006, employing two indicators derived from the International Country Risk Guide (ICRG).
• The authors discover that equity risk premiums are indeed higher in countries experiencing more policy risk from either source, with the presence of increased bureaucratic risk leading to a roughly 8% rise in the premium.

Policy instability increases uncertainty in financial markets.

• The article investigates the impact of policy instability on international equity markets.
• It discusses how policy instability could increase uncertainty in financial markets.
• Empirical evidence from 57 democratizing countries indicates that equity risk premiums rise during periods of democratization.
• Central banks can affect equity risk premiums through aggressive interest rate cuts, signaling expectations for future growth and potential risks.
• The study cites another paper that links political crises to increased equity risk premiums, particularly for sectors most vulnerable to the crisis.
• Taxation could explain high equity returns since World War II due to falling marginal tax rates.
• Equity risk premiums vary significantly across nations, with considerable standard errors in estimates.
• So-called "survivor markets" like the United States, which have long histories in equity markets, exhibit much lower returns over certain periods compared to newer markets.
• Using volatility as a measure of risk can be misleading, as volatility can be affected by liquidity issues apart from intrinsic risk.
• Nevertheless, volatility measures continue to be widely employed, especially during stable periods and upward trends.
• These measures can, however, shoot up dramatically during crises such as the one faced in late 2008.
• The data provided displays the variability in relative volatility estimates, with wide variations between countries and years.
• Although there has been a decrease in volatility following the financial crisis, equity risk premiums have exhibited greater volatility since 2008 when compared to pre-crisis levels.
• During the Covid crisis of 2020, similar volatility in equity risk premiums was observed as during the financial crisis of 2008.
• This was not confined to just the US; global equity markets were likewise affected.
• Corporate bond markets also experienced heightened volatility, with default spreads widening considerably and commercial paper and LIBOR rates rising sharply.
• Simultaneously, the 3-month Treasury bill rate dropped close to zero, underscoring the strong interdependence between risky asset markets.
• In 2008, all three markets - real estate, equities, and bonds - moved almost synchronously, with risk premiums rising and prices falling.
• The real estate equity risk premium dips during the years of the housing bubble, reaching below 2% in 2006.
• The subsequent fall in property prices pushed the premium back up.
• The adjustment of equity and bond premiums back to pre-crisis levels happened swiftly in 2009 and 2010, with real estate premiums following suit, albeit slower.
• The VIX fell between September 2011 and March 2012 without a corresponding reduction in the implied equity risk premium; however, these premiums reduced the following year.
• Despite low VIX values for most of 2014, equity risk premiums increased over the course of the year.
• Toward the end of 2015, the VIX spiked again due to global market crises, leading to an increase in the equity risk premium as well.
• Today's investors have access to more global portfolio diversification options thanks to international mutual funds and ETFs.
• However, a substantial home bias persists, with most investors heavily investing in their domestic market.
• Some earlier studies suggested low correlation between returns across countries, supporting the case for global diversification, but more recent studies indicate higher correlation levels owing to increasing global interdependence.

Diversification does not always protect businesses operating in several emerging markets from risk

• The contagion effect can undermine the notion that businesses operating in several emerging markets are shielded from risk due to diversification advantages.
• During the 2008 financial crisis, there were strong correlations between stock index movements in numerous markets, signifying synchronized market behaviour.
• The influence of globalization on equities is examined, revealing that the correlation among worldwide equity markets rises during bear markets.
• Additionally, exposure to global political uncertainty appears to be greater in integrated markets, while exposure to domestic political uncertainty seems to be greater in segmented markets.
• This assertion is backed up by a study conducted on 36 countries between 1991 and 2010.
• Moreover, the source explains how beta coefficients for stocks in various markets are estimated.
• Risk adjustment is a crucial concept in finance, adjusting anticipated cash flows based on their associated risk.
• This helps to account for uncertainty and volatility in investments.
• For instance, a company contemplating investing in two nations--one mature and one emerging market--might find that between 2014 and 2016, credit default swap spreads widened considerably in both developing and frontier markets, mainly due to political and corporate scandals.
• Some argue that examining the average spread over a period rather than the spot rate might be more fitting.
• Nonetheless, this approach only works if the underlying economic fundamentals remain stable throughout the time frame.
• For instance, in 2008, using an average over time would have been apt for Nigeria owing to its reliance on oil prices leading to fluctuating spreads.
• However, it wouldn't have been suitable for countries like China and India that experienced significant economic growth or Venezuela, which witnessed escalating political instability and a resultant rise in default spreads.
• The author suggests incorporating the CDS spread (or a multiple of it) into the cost of equity and capital to account for country risk.
• The table above lists Latin American countries with their respective equity market volatility and risk premiums relative to the United States.
• It indicates that Argentina has the highest relative equity volatility at 56.52%, followed by Brazil at 16.21%.
• In terms of risk premiums, Argentina leads with 20.95%, while Venezuela ranks second at 11.42%.
• The data also reveals that the United States has a relatively low relative equity volatility of 12.41% and a risk premium of zero.
• However, these figures might be influenced by the differing liquidity levels in these markets, with more liquid markets typically exhibiting higher volatility.
• As a result, the use of standard deviations computed in markets with varying structures and liquidity might lead to misleading premium calculations.
• This source explores the challenges involved in measuring the relative volatility of equity markets in emerging economies.
• The author identifies three primary issues--the instability of the relative standard deviation of equity, the necessity to estimate bond volatility, and the problem of low trading volumes for government bonds.
• To compute the standard deviation of CDS in basis points over the previous 260 trading days, the sCDS is used, and the coefficient of variation is obtained by dividing this standard deviation by the CDS level.
• The electronic copy of this information can be accessed via a link provided.
• To compute the equity risk premiums by country, default spreads are scaled up by a global factor considering the relative volatility of equity markets compared to government bonds.
• The source is the "Credit Suisse Global Investment Returns Yearbook" by Dimson, Marsh, and Staunton from 2018, available on the Credit Suisse website.
• The report investigates the valuation of equities in markets heavily exposed to political and economic risk, considering factors like the diversifiability of country risk, the openness or segmentation of markets, and the applicability of one-factor vs multi-factor models.

Country risk premia should not affect equity risk premiums; market-level volatility differences should be accounted for when calculating the certainty equivalent cash flow on an investment

• This source discusses the implications of country risk premia on equity risk premiums and hurdle rates in a globalized economy.
• Arguments are made against the practice of demanding higher risk premiums for investing in certain countries, claiming that country risk is diversifiable and only non-diversifiable market risks are relevant for assessing the cost of equity.
• The article suggests adjusting individual companies' betas to account for market-level volatility differences between regions, and using this approach to calculate the certainty equivalent cash flow on an investment in a country by adjusting the return of the investment to account for the beta of the relevant market.
• It also discusses the limitations of ratings agency measures, suggesting market-based measures as an alternative for those who believe ratings agencies are slow to react or have too narrow a view of risk.

Calculate a default spread for a country by adjusting country risk premiums over time.

• This report explains how to calculate a default spread for a country.
• Various methods exist, including calculating the bond default spread, credit default swap spreads, and imputed or synthetic spread.
• The former requires foreign currency bonds, while the latter two involve comparing the country's credit rating with others or scaling the country risk premium to estimate the cost of equity.
• The paper suggests that country risk premiums decrease over time, particularly for risky and fast-evolving markets.
• To adjust these premiums, it recommends starting with the premium that comes from the blended method and gradually reducing it towards either the country bond default spread or even a regional average.