Capm

While the CAPM plays this role in developed                                                                                          

Markets, no model currently does so in emerging markets                                                            

Required return on equity (R): R(e) = Rf+ MRP·SR + A

where Rf denotes the risk-free rate, MRP the (world) market risk  premium, SR the specific risk of an investment opportunity,

and A some additional adjustment

1. The Lessard Approach1

SR = βp·βc   R = Rf + MRP·( βp·βc).

The project beta can be estimated as the beta of the relevant industry with respect to the world market, and the country beta as the beta of the relevant country also withrespect to the world market. No further adjustments are implemented in this approach and, therefore, A=0.

1. The Godfrey-Espinosa Approach 2

and second, measures risk as 60% of the volatility of the stock market of the country in which the project is based relative to the volatility of the world market (σc/σ W ). More precisely, σc and σW are the standard deviation of returns of country c’s stock market and that of the world market

A = YSc  ,   SR = (0.60)·(σc/σ W ),

R = (Rf +YS c) + MRP·{(0.60)·(σc/σ W )

Note that in this model the specie c nature of the projects ignored. Put differently, it makes no difference whether accompany is evaluating a project in the oil, airline, or telecom-medications industries; what matters is the country in which the project is based

1. The Goldman Sachs Approach 3

If the stock market and

the bond market are perfectly correlated (ρSB=1), they both

refl ect the same sources of risk; in that case YSc will capture all the relevant risk of investing in country c and, therefore, R = Rf +YS c. If, on the other hand, the stock market and the bond market are

Uncorrelated (ρSB=0), each reflects different sources of risk; in that case, YSc quantifies the risk reflected by the bond market, σc/σ W

the additional risk reflected by the stock market and R = (Rf +YS c)+MRP·(σc/σ W ). For all practical

purposes it is the case that 0<ρSB<1. Therefore, this model

incorporates the risk reflected by both the stock market and

the bond market without double counting sources of risk.

SR = (1–ρSB)·(σc/σ W ) ,   A = YSc .

R = (Rf +YS c) + MRP·{(1–ρSB)·(σc/σ W )} .

Ρsb: Correlation between the country’s stock market and bond market returns.