In many emerging markets, there is little historical data, and the data that exists is too volatile to yield a meaningful estimate of the risk premium. To estimate the risk premium in these countries, let us start with the basic proposition that the risk premium in any equity market can be written as follows:
Equity risk premium = Base premium for mature equity market + Country premium
The country premium could reflect the extra risk in a specific market. This boils down our estimation to answering two questions:
• What should the base premium for a mature equity market be?
• How do we estimate the additional risk premium for individual countries?
To answer the first question, we will ...