gold investment, silver investment

Precious metals investment terms A to Z

Country risk premium

The country risk premium refers to the difference between the higher interest rates that less stable and riskier countries must pay to attract investors, and the interest rates of an investor’s home country.

By investing in less stable and poorly-rated countries you can expect a higher return, but you also have to accept a higher level of risk. For example El Salvador is a much more probable candidate for insolvency than Germany.

Investing in Bolivia is considered riskier than investing in the USA. Have you ever wondered how this "riskiness" can be calculated? The answer is particularly important to investors in junior mining stocks who could be particularly affected by geographical (and legal) risk. For instance, if a certain company's mines are suddenly nationalized then the stock price will plummet.

Country risk in the above example is based on different economic concepts and policies introduced throughout the years as well as some external factors. The situation is so complex that the difference seems to be unexplainable at first sight. However, thanks to the country risk premium, we are able to measure, define and compare such differences with a decent accuracy. As a result, we are better able to estimate risk associated with investing in junior stocks with operations in various countries.

The country risk premium is the difference between the imposed market interest rates for the government of a given country (often called the benchmark country) and comparable rates for other countries. Usually this term refers to a positive divergence between these rates.

The benchmark country is a country with a stable, well-respected and developed business environment. These countries are often referred to as “low risk” or “developed.” Thanks to these conditions, the cost of capital and consequently, the expected returns on low-risk investment projects, remain at a stable but relatively unimpressive level. This term is commonly used in reference to government bonds. The USA is an example of a benchmark country. In other countries with a less attractive business environment investors may be more reluctant to make loans or invest in the market. That is why the government has to offer relatively higher interest rates compared to those of the benchmark country. Investors are more willing to accept the risk if the risk premium is higher.

To sum up, the country risk premium may be defined as an investor’s premium for accepting a higher level of overall risk in the business environment. The relative risk levels in various countries may be easily compared using bond- or sovereign ratings issued by the rating agencies (Moody’s, S&P, Fitch). The lower the rating, the higher the risk. Investors have to be aware of the fact that the relationship between country risk and country risk premium may be flawed. The optimum level of acceptable risk has to be estimated according to other economic factors and principles.

A wise investor will always think about the possible costs and profits of each investment, especially when considering investing in riskier countries. In some cases it may pay off, while in others it can be a total flop. Proper diversification is an important caveat. By smart diversification one can minimize the "sum of risks" or even make the particular countries' risks cancel each other out. To do this you need proper tools and data. We demonstrate how this can be done below.

Before we continue, please note that one of the ways to limit the risk in one's portfolio is through diversification - adding assets that are less / not correlated (or negatively correlated) with the rest of one's portfolio. Gold and the rest of the precious metals sector, might be particularly useful in this case, and if you'd like to learn more about this topic, we invite you to sign up for our gold mailing list. It's free and if you don't like it, you can easily unsubscribe. Sign up using this link today.

Moving back to the core topic of this page, the common way of measuring the country risk premium is by taking the difference between the country's average bond yield and the default-free government's bond yield (a bond whose issuer is highly unlikely to default – for example US T-bonds). Please look at the table below, based on the work of Professor Aswath Damodaran of the Stern School of Business at NYU (original version available here). The table shows the level of country risk premium by country (as of 2011), as well as the long term rating issued by the rating agencies. US T-bonds were used as default-free bonds:

Country Long-Term Rating Country Risk Premium
Albania B1 6.00%
Angola B1 6.00%
Argentina B3 9.00%
Armenia Ba2 4.13%
Australia Aaa 0.00%
Austria  Aaa 0.00%
Azerbaijan Ba1 3.60%
Bahamas A3 1.73%
Bahrain A3 1.73%
Bangladesh Ba3 4.88%
Barbados Baa2 2.63%
Belarus B1 6.00%
Belgium  Aa1 0.38%
Belize B3 9.00%
Bermuda Aa2 0.75%
Bolivia B1 6.00%
Bosnia and Herzegovina B2 7.50%
Botswana A2 1.50%
Brazil Baa3 3.00%
Bulgaria Baa3 3.00%
Cambodia B2 7.50%
Canada Aaa 0.00%
Cayman Islands Aa3 1.05%
Chile Aa3 1.05%
China Aa3 1.05%
Colombia Baa3 3.00%
Costa Rica Baa3 3.00%
Croatia Baa3 3.00%
Cuba Caa1 10.50%
Cyprus  Aa3 1.05%
Czech Republic A1 1.28%
Denmark Aaa 0.00%
Dominican Republic B1 6.00%
Ecuador Caa3 15.00%
Egypt Ba1 3.60%
El Salvador WR 15.00%
Estonia A1 1.28%
Fiji Islands B1 6.00%
Finland  Aaa 0.00%
France  Aaa 0.00%
Georgia Ba3 4.88%
Germany  Aaa 0.00%
Greece  Ba1 3.60%
Guatemala Ba1 3.60%
Honduras B2 7.50%
Hong Kong Aa1 0.38%
Hungary Baa3 3.00%
Iceland Baa3 3.00%
India Ba1 3.60%
Indonesia Ba2 4.13%
Ireland  Baa1 2.25%
Isle of Man Aaa 0.00%
Israel A1 1.28%
Italy  Aa2 0.75%
Jamaica B3 9.00%
Japan Aa2 0.75%
Jordan Baa3 3.00%
Kazakhstan Baa2 2.63%
Korea A1 1.28%
Kuwait Aa2 0.75%
Latvia Baa3 3.00%
Lebanon B1 6.00%
Lithuania Baa1 2.25%
Luxembourg  Aaa 0.00%
Macao Aa3 1.05%
Malaysia A3 1.73%
Malta  A1 1.28%
Mauritius Baa2 2.63%
Mexico Baa1 2.25%
Moldova B3 9.00%
Mongolia B1 6.00%
Montenegro Ba3 4.88%
Morocco Ba1 3.60%
Netherlands  Aaa 0.00%
New Zealand Aaa 0.00%
Nicaragua B3 9.00%
Norway Aaa 0.00%
Oman A1 1.28%
Pakistan B3 9.00%
Panama Baa3 3.00%
Papua New Guinea B1 6.00%
Paraguay B1 6.00%
Peru Baa3 3.00%
Philippines Ba3 4.88%
Poland A2 1.50%
Portugal  A1 1.28%
Qatar Aa2 0.75%
Romania Baa3 3.00%
Russia Baa1 2.25%
Saudi Arabia Aa3 1.05%
Singapore Aaa 0.00%
Slovakia A1 1.28%
Slovenia  Aa2 0.75%
South Africa A3 1.73%
Spain  Aa1 0.38%
Sri Lanka B1 6.00%
St. Vincent & the Grenadines B1 6.00%
Suriname Ba3 4.88%
Sweden Aaa 0.00%
Switzerland Aaa 0.00%
Taiwan Aa3 1.05%
Thailand Baa1 2.25%
Trinidad and Tobago Baa1 2.25%
Tunisia Baa2 2.63%
Turkey Ba2 4.13%
Ukraine B2 7.50%
United Arab Emirates Aa2 0.75%
United Kingdom Aaa 0.00%
United States of America Aaa 0.00%
Uruguay Ba1 3.60%
Venezuela B1 6.00%
Vietnam B1 6.00%

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