Professional Documents
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eurobonds spread
( ) ( )
US
f M
P S
ketIndex CountryMar
US
f M
R R R R =
500 &
o
o
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Measures of risk (I)
Beta a measure of systematic risk;
defined as the sensitivity of an assets returns
to changes in the markets returns (domestic
or/and global);
Standard deviation of an assets returns - a
measure of the total risk of the asset;
Total beta a measure of the asset's total
risk relative to market risk;
Beta vs. relative volatility
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Measures of risk (II)
Total beta derived calculation:
2 2 2 2
c
o o | o + =
M i i
Systematic Risk Companys Specific Risk
) 1 (
2
,
2 2 2
,
2 2 2 2 2
M i i i M i i M i i
o o o o | o o
c
= = =
) 1 (
2 2 2
R
i
=o o
c
) 1 (
2 2 2 2 2 2 2 2
R
i M i M i i
+ = + = o o | o o | o
c
2 2 2
2
2
2
M M
i
i
T
R
o | o
|
o = =
M
i
T
o
o
| =
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Measures of risk (III)
Semideviation of assets returns below the
mean or other benchmark return a
measure of the asset's total downsize risk;
Downsize beta - a measure of the asset's
downsize systematic risk;
Regular beta understates risk of low-beta
stocks and overstates risk of high-beta
stocks.
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Compensation for risk - EPR
What should we consider?
short term vs. long term investors perspective of
risk;
market characteristics :
Size
Liquidity
Skewness
Integration in world market
idiosyncratic (firm specific) risk
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Skewness of assets returns
distribution impact on ERP
Standard deviation and beta as a measure
of risk are not relevant when the
underlying distributions of returns is not
symmetric;
Semideviation and downsize beta capture
the returns distribution asymmetry;
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Emerging market integration in the
world market
In applying CAPM to estimate beta of an
investment in an emerging market what
market portfolio should we consider?
Local market portfolio;
or
Global market portfolio;
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What beta do you choose for
SNP (Petrom)? (I)
*Beta SNP is estimated for weekly total returns (EUR) and 5 years period (Apr 2009 Apr 2004).
Market
index
BETC BET ROTX MXWD MXEF MXEE MXEU S&P500
Beta 1.078 1.012 0.966 0.974 0.824 0.734 0.970 0.694
Alfa 0.0007 0.0003 0.0002 0.002 0.0004 0.0007 0.002 0.002
R
2
0.639 0.631 0.628 0.161 0.2 0.204 0.208 0.092
SE Alfa 0.002 0.002 0.002 0.003 0.003 0.003 0.003 0.003
SE Beta 0.051 0.048 0.046 0.14 0.103 0.091 0.119 0.137
Total
Beta
1.348 1.274 1.219 2.427 1.842 1.625 2.126 2.288
What beta do you choose for
SNP (Petrom)? (II)
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Market
index
BETC BET ROTX MXWD MXEF MXEE MXEU S&P500
DBeta 1.135 1.322 1.015 1.504 1.234 1.111 1.112 1.331
R
2
0.672 0.115 0.623 0.217 0.267 0.255 0.255 0.267
SE Beta 0.041 0.127 0.041 0.117 0.089 0.081 0.081 0.096
Relative
Semi-
deviation
2.355 2.024 1.314 2.396 1.877 1.709 1.710 1.710
*DBeta SNP is estimated for weekly total returns (EUR) and 5 years period (Apr 2009 Apr 2004).
The benchmark return is the arithmetic average weekly return.
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How do we measure local capital
market integration?
can be used to measure how integrated
the domestic market is in the global market;
( )
t t
t
WM LM t t LMt
Rf R Rf R c | o + + =
2 2
) (
LMGM
R =
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Local Capital Market integration (I)
The figures are estimated for weekly total returns (EUR), 3 years period (Apr 2006 Apr 2009)
and considering MXWD index.
Index Beta t-stat R
2
Index Beta t-stat R
2
BETC 0.971 8.323 0.314 RTSI 1.149 8.459 0.321
BG40 0.708 5.735 0.204 BUX 1.231 12.38 0.499
SVSM 0.611 8.493 0.319 CRO 0.770 8.211 0.304
VILSE 0.545 7.416 0.263 WIG 1.069 11.61 0.467
XU100 1.555 13.54 0.543 UKX 1.175 28.11 0.836
TALSE 0.480 5.812 0.179 CAC 1.109 27.12 0.826
RIGSE 0.360 4.992 0.139 DAX 1.154 26.00 0.814
PFTS 0.644 4.413 0.114 SPX 0.984 31.99 0.869
Local Capital Market integration (II)
The figures are estimated for weekly total returns (EUR), 3 years period (Apr 2003 Apr 2006)
and considering MXWD index.
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Index Beta t-stat R
2
Index Beta t-stat R
2
BETC 0.177 1.053 0.007 RTSI 0.939 5.125 0.147
BG40 - - - BUX 0.483 3.199 0.062
SVSM 0.034 0.490 0.001 CRO 0.017 0.121 0.000
VILSE 0.237 1.845 0.021 WIG 0.714 5.683 0.173
XU100 0.787 3.444 0.072 UKX 0.778 17.51 0.665
TALSE 0.311 2.999 0.055 CAC 0.849 18.80 0.696
RIGSE 0.319 2.734 0.046 DAX 1.07 17.35 0.661
PFTS 0.399 1.834 0.021 SPX 1.06 37.37 0.90
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How does beta reflect the impact of
market integration?
LM
iLM i
LM
iLM LM i
i
o
o
o
o o
|
=
=
2
WM
LMWM LM
WM
LMWM WM LM
LM
o
o
o
o o
|
=
=
2
LMWM
WM LM
LM
o |
o
=
WM
LMWM iLM i
LM i
o
o
| |
=
Market Risk Premium
Market risk premium represent extra
percentage points over the risk free rate
(Rf) that investors get when they invest in
market portfolio;
Market risk premium = RM - Rf
Domestic or global?
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BETC weekly returns statistics
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0
20
40
60
80
100
120
140
-0.2 -0.1 0.0 0.1
Series: BETC_WEEKLY_RETURNS_EU
Sample 1 474
Observations 474
Mean 0.002120
Median 0.002498
Maximum 0.164857
Minimum -0.252715
Std. Dev. 0.043092
Skewness -0.733249
Kurtosis 6.998025
Jarque-Bera 358.1626
Probability 0.000000
BETC 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
YR
M
-16.28% -16.51% 65,38% 7,38% 77,41% 42,19% 33,52% 30,84% -119,55% -8,62%
Y
29.23% 32.61% 29,47% 15,75% 21,52% 30,40% 20,87% 28,10% 29,93% 30,98%
YR
M
= yearly BETC average return; Y = yearly standard deviation of BETC returns. The figures are estimated by annualizing weekly average return
(measured in EUR) and standard deviation.
M
R
o
M
R
o
EPR estimation for emerging
markets example of models
recommended in finance literature
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Erb, Harvey and Viskanta model
(1996)
The case of emerging economies without capital
market or with one that has a short history
or/and low liquidity:
Risk ratings are available from Institutional Investors Country Credit
Risk, Euromoneys Country Risk Ratings, International Country Risk
Guide.
Cost of capital estimates for 136 countries are offered by the
program International Cost of Capital and Risk Calculator
(see http://www.duke.edu/~charvey/applets/iccrc.html).
( )
1 , , 1 0 ,
ln
+
+ + =
t i t i t i
CCR R c
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Lessard model (1996)
For segmented markets:
( )
LM i US f US M C US f i
R R SS R K | | + + =
, , ,
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Godfrey-Espinosa model (1996)
For segmented markets:
The coefficient 60% is meant to avoid double counting of risk and
represent the average across emerging economies of the risk
reflected by the stock market and not reflected by the bond market.
( )
WM
LM
f C LM E
R SS Rf K
o
o
+ + = % 60 R
WM ,
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Goldman Sachs model (1999)
For segmented markets:
- the correlation coefficient between local capital
market returns and T-bonds yields.
( ) ( )
WM
LM
LMBM f C LM E
R SS Rf K
o
o
+ + = 1 R
WM ,
LMBM
+ =
US E
LM E
US f US M i US f i
R R R K
,
,
, , ,
o
o
|
( )
LM B
LM E
C i US f US M i US f i
SS R R R K
,
,
, , ,
o
o
| + + =
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Butler Pinkerton Model (2007)
For integrated markets, and considering
company specific risk and size risk:
For private companies the estimation of CSPR for guideline companies
is followed by an analysis of private company specific risk factors.
( )
US f US M i US f i
R R T R TCOE
, , ,
+ = |
( )
i i US f US M i US f i
CSRP SP R R R TCOE + + + =
, , ,
|
( ) ( )
i US f US M i i i
SP R R T CSRP =
, ,
| |
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Cost of equity estimation -
aplication
Model Estimations K
SNP
Lessard model (1996)
K
SNP
= 3%+2.6%+6%x1.076x0.928 11.59%
Godfrey-Espinosa model
(1996)
K
SNP
= 3%+2.6%+6%x60%x(5.12%/2.78%) 12.33%
Goldman Sachs model
(1999)
K
SNP
= 3%+2.6%+6%x(1-0)x(5.12%/2.78%) 16.65%
Estrada model (2002) K
SNP
= 3% + 1.331x6%
K
SNP
= 3% + 1.710x6%
10.99%
13.26%
Damodaran model (1999) K
SNP
= 3% + 1.078x[6%x(5.12%/2.78%)]
K
SNP
= 3% + 1.078x6% + 1x2.6%x1.5
14.91%
13.64%
Butler Pinkerton Model
(2007)
K
SNP
= 3% + 2.28x6% 16.68%
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Which model would you chose
to estimate the discount rate
for an investment in an emerging market?
Erb, Harvey and Viskanta model (1996)
Lessard model (1996)
Godfrey-Espinosa model (1996)
Goldman Sachs model (1999)
Estrada model (2002) DCAPM
Damodaran model (1999)
Butler Pinkerton Model (2007)
None of them.
Ideas from some of them.
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Challenges of ERP estimation for
emerging markets
Frequent re-estimations are necessary;
The prospective EPR should include information
about probable changes in market characteristics
(e.g. degree of integration in global market);
Problems of transparency and illiquidity;
Short history of transactions.
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In ERP estimation we need a firm place to
stand on and maybe we will move the
Earth!
Thank you for joining us.
Please remember to turn in your
evaluation forms.
Plan to join us next year for our
Seventeenth Annual Conference.
Glossary of Abbreviations used in these slides (I)
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Abbreviation Meaning
R
f
Risk free rate (T-bond yield, 10 years maturity);
SS
c
Sovereign spread for country C;
CCR
i,t
Country Credit Risk for country i at the moment t;
R
M
(R
WM
) Market Return (local market return-R
LM
or world market return-R
WM
)
R
i,t
Market Return of country i at the moment t;
K
i
Cost of equity for the investment in asset i;
K
E,LM
Cost of equity for the investment in local capital market;
TCOE
i
Total cost of equity for the investment in asset i;
Standard deviation of returns for risky asset i;
Standard deviation of returns for local capital market portfolio;
Standard deviation of returns for world capital market portfolio;
Standard deviation of yields for T-bonds issued by country i;
SP
i
Size premium for the investment in asset i;
CSRP
i
Company specific risk premium for the investment in asset i;
i
o
LM
o
WM
o
LM B,
o
) (
,LM E
o
Glossary of Abbreviations used in these slides (II)
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Abbreviation Meaning
Correlation between the risky asset i and local market portfolio
returns;
Correlation between the local and world market portfolios returns;
Correlation between the local stock and T-bond markets returns;
Beta of the investment in asset i;
Beta of the investment in local market portfolio with respect to the
world market portfolio;
Downsize beta of the investment in asset i;
Total beta of the investment in asset i;
The company i exposure to country risk;
Relative semideviation of asset i returns below its mean with respect
to the semideviation of market portfolio returns below its mean.
R
2
Regression coefficient of determination
SE Alfa/Beta Standard error of Alfa/Beta coefficients estimates;
iLM
LMWM
LMBM
i
|
LM
|
D
i
|
i
i
T|
US M
i
SD
SD
,
Selected Bibliography:
Butler, P.J.; K.A. Pinkerton (2008), The Butler Pinkerton Model: Empirical Support for
Company-Specific Risk, The Value Examiner, May/June, 32-39
Damodaran, A. (2008), Equity Risk Premiums (ERP): Determinants, Estimation and
Implications, working paper, SSRN n. 1274967
Estrada,J. (2002), Systematic risk in emerging markets: the D-CAPM, Emerging Markets
Review, 365-379
Estrada,J. (2007), Discount Rates in Emerging Markets: Four Models and An
Application, Journal of Applied Corporate Finance, volume 19, Number 2, 72-77
Fernandez, P. (2008), "The Equity Premium Puzzle: high required equity Premium,
undervaluation and self fulfilling prophecy IESE Business School Working paper, SSRN
n. 1274816.
Graham, J.R., C.R. Harvey (2001), The theory and practice of corporate finance:
evidence from the field, Journal of Financial Economics, Vol. 60 No 2/3, pp. 187-243.
Graham, J.R., C.R. Harvey (2007), "The Equity Risk Premium in January 2007: Evidence
from the Global CFO Outlook Survey, Icfai Journal of Financial Risk Management, Vol.
IV, No. 2, pp. 46-61.
Harvey, C.R., (2005), 12 ways to calculate the international cost of capital, working
paper, Duke University
Pratt,S., R.,Grabowski, (2008), Cost of Capital: Applications and Examples, Third
Edition, John Wiley&Sons,Inc.
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