Formula to Calculate Country Risk Premium

Country risk refers to the risk of a foreign country defaulting or becoming unable to pay its debt on time. Country risk is primarily concerned with investing in a foreign country, and includes various risks such as political risk, foreign exchange risk, and sovereign risk. Country risk must be taken into consideration while making investment decisions, and usually incorporated in the risk in the form of country risk premium.

The general formula for calculating the country risk premium is as follows:

Country Risk Premium (CRP) = Yield of Sovereign bond denominated in USD - Yield of US T-note

We can also calculate the country equity premium using the following formula:

$Country\ Equity\ Premium = Country\ Default\ Spread \frac{\sigma_{Equity} }{\sigma_{Country\ Bond}}$

Prof. Aswath damodaran maintains a list of country risk premiums for various countries. His method of calculating country risk premium by obtaining the default spread as follows:

1. Use local currency sovereign rating, and calculate default spread for that rating over the risk-free rate, or
2. Obtain CDS spread for the country and subtract US CDS spread, which give sthe country premium.