Country Risk Premia and Beta in CAPM Valuation
Summary
The document raises a question about choosing an equity risk premium (ERP) for a company operating across countries. It contrasts using the premium associated with the company’s listing or headquarters with weighting country ERPs by revenue, operating income, or fixed assets. An Israeli software company earning nearly all its revenue in the United States illustrates why operating exposure might matter more than domicile.
The central issue is whether a company’s market beta already captures its geographic exposure, making a weighted ERP an additional adjustment that could count the same risk twice. The text offers this as an unresolved question rather than a settled valuation method. It provides no empirical evidence or answer, so it is useful as a framing of the distinction between market sensitivity and country risk assignment, but does not establish when either ERP approach is appropriate.
Key ideas
- A company’s headquarters or listing country may not reflect where it earns revenue.
- Some practitioners weight country ERPs by operating exposure measures such as revenue or assets.
- The document asks whether beta already accounts for geographic exposure, creating a risk of double counting.
- It presents the issue for discussion and supplies no evidence or definitive resolution.
Tags
Full text
# Betas and weighted average ERP # Betas and weighted average ERP Whenever analyzing a particular company through CAPM, I used to take the Equity Risk Premium (ERP) of the country where the company was listed/headquartered. However, recently I came to know that some practitioners don't consider it a good choice. The reason that they give is that assume that you have an Israeli software firm which is listed in Tel Aviv but c.100% of its revenues come from the USA. In such a case, these practitioners believe that the firm must be rewarded for having a more developed country as its revenue source and ergo, as a general practice, they take a weighted average of ERPs of different countries in which the company operates in weighted by revenue/operating income/fixed assets. This approach seems logical enough given that it punishes companies headquartered in developed countries but having their revenue sources in riskier countries and vice versa. However, one aspect of the approach that I haven't been able to understand is that doesn't the beta of the security already do this job. Isn't the beta for such firms (say the Israeli firm that has 100% of its revenues from the USA) already rewarding and punishing them for this aspect of their operation? Since such firms are more dependent on the developed markets, I would expect their beta to be less sensitive to the markets of their incorporation and hence it seems to me that if we are using beta for the exchanges on which these firms are listed and a weighted average ERP, we are rewarding/punishing such firms twice. Kindly help me understand this better or redirect me to some study that has been considered on the same. Any help would be appreciated.
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