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.



Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Browse other questions tagged or ask your own question.