What is country risk premium (CRP)?
The country risk premium (CRP) is the additional return investors require for investing in a country with greater risk than a mature reference market. It captures risks such as political instability, sovereign default, economic uncertainty and market volatility. In business valuation, the CRP is commonly incorporated into the cost of equity.
What are country risks?
When companies operate internationally, they face a variety of risks with every foreign investment. These go far beyond the usual entrepreneurial challenges.
Country risks are based on the specific political, economic and social conditions of a country. They can differ considerably from those of the domestic market.
The factors influencing them include geopolitical tensions, political instability, exchange rate fluctuations, unpredictable interest rate developments and high inflation rates. Taken as a whole, they can have a significant impact on a company’s business environment abroad.
Moreover, foreign investments often entail risks such as:
- Tax uncertainties: Changes in tax legislation or inconsistent interpretations can lead to considerable financial burdens.
- Legal and regulatory risks: Different legal systems and constantly changing regulations make it difficult to comply with legal requirements.
- Business and credit defaults: The creditworthiness of business partners abroad can be impaired due to economic or political crises.
- Legal disputes: Cultural differences, language barriers and complex legal systems increase the risk of legal disputes.
These risks can lead to considerable financial losses. They are also likely to impair the competitiveness of companies. A thorough analysis and assessment of country risks is therefore essential before any foreign investment.
How country risks can be taken into account in the business valuation
Country risks pose a challenge for business valuation. This is because they make it difficult to determine the future cash flows of a company. Two basic approaches make it possible to include these risks in a valuation:
- Adjustment of cash flows: Country risks can theoretically be taken into account directly in the forecasts of future cash flows. However, this would require a very detailed and often unrealistic assessment of the probabilities and financial effects of individual risks. In practice, it is difficult to precisely quantify the effects of political unrest, regulatory changes, natural disasters or other unforeseeable events.
- Increasing the cost of capital: It is more common and pragmatic to increase the company’s cost of capital. These costs of capital represent the minimum return that investors expect for their invested capital. By incorporating a country risk premium into the cost of equity, the increased risk of investing in a particular country can be reflected in the discount rate.
There are three reasons for including risks in the cost of capital:
- Simpler: Increasing the cost of capital is a relatively simple approach to taking country risks into account.
- More conservative: Higher costs of capital make the valuation more conservative, as future cash flows are discounted at a higher rate.
- Standard market practice: Country-risk adjustments are widely used in international valuation practice.
By including country risks in the cost of capital, the valuation of a company can better reflect the additional uncertainty associated with a foreign investment.
CRP in valuation
The Capital Asset Pricing Model (CAPM) serves as the basis for calculating the cost of equity. In an international context, this model can be extended to include a country risk premium.
The standard CAPM is:
Ke = Rf + β × MRP
where:
- Ke = cost of equity
- Rf = risk-free rate
- β = beta factor
- MRP = market risk premium
For an international valuation, a country-risk component can be incorporated into the market-risk component. One commonly used construction is:
Ke = Rf + β × (MRP + CRP)
The exact treatment depends on the valuation framework and on how the country risk is measured. The important point is to avoid double-counting: a local risk-free rate or market premium may already incorporate some country-specific effects.
The country risk premium is important for several reasons:
- Investors demand a higher return for higher country-specific risk.
- Incorporating the CRP can make the valuation more representative of the risk environment in which the company operates.
- The CRP facilitates comparison between companies exposed to different country-risk environments.
- It provides a transparent way of documenting a country-risk adjustment in the cost of equity.
How to calculate the CRP
There is no single universally correct calculation. The appropriate method depends on the availability and quality of market data, the country concerned and the valuation framework.
A widely used Damodaran-style approach starts with a sovereign default spread and adjusts it to reflect the higher risk of equity markets. Damodaran’s current methodology starts with a sovereign rating and corresponding default spread, adds an adjustment for the relative volatility of equity markets, and then adds the resulting country risk premium to a mature-market equity risk premium (cf. Aswath Damodaran, 2026; unknown.)
Step 1: Determine the sovereign default spread
Start with a sovereign rating and estimate the corresponding default spread over a default-free government bond.
For example, Damodaran’s January 2026 data assigns Brazil a Ba1 rating and an adjusted default spread of 2.13%.
Step 2: Adjust the default spread for equity risk
The default spread measures sovereign credit risk, but equity investors are exposed to greater volatility than holders of government debt.
Damodaran therefore adjusts the default spread using the relative volatility of equity and bond markets. His current dataset reports a 3.24% country risk premium for Brazil, compared with the 2.13% adjusted default spread.
Conceptually:
CRP = Default Spread × Relative Equity/Bond Risk Adjustment
The precise inputs and adjustment methodology should be documented rather than treated as a universal fixed multiplier.
Step 3: Add the CRP to the mature-market risk premium
The country risk premium is then added to the mature-market equity risk premium to obtain a total equity risk premium.
For Brazil in Damodaran’s January 2026 dataset:
Mature-market ERP + Brazil CRP
4.23% + 3.24% = 7.47%
The resulting 7.47% is the total equity risk premium reported for Brazil in the dataset.
Step 4: Incorporate the CRP into the cost of equity
For a company with a beta of 1.10, using the illustrative Brazilian figures above:
Ke = Rf + 1.10 × 7.47%
If the applicable risk-free rate were 4.00%, this would give:
Ke = 4.00% + 1.10 × 7.47% = 12.22%
This is an illustrative calculation. The risk-free rate, beta, country risk premium and valuation date must all be consistent with the actual valuation.
Step 5: Check the company’s actual exposure to country risk
A country risk premium does not necessarily have to be applied mechanically at 100% to every company operating in the country.
A multinational company may generate only a small proportion of its revenues or earnings in the country being assessed. Conversely, a company whose business is concentrated entirely in that country may have much greater exposure.
Damodaran therefore also discusses approaches that adjust country-risk exposure using a company-specific lambda, based for example on the proportion of revenues or earnings exposed to the country or on the relationship between company returns and country-risk indicators.
How to determine CRP
The three broad approaches are not necessarily mutually exclusive. Damodaran’s methodology itself uses sovereign credit information as a starting point and then adjusts it to reflect the additional risk of equity markets.
CRP, according to Damodaran
Aswath Damodaran is known for his work in the field of business valuation. As Professor of Finance at the New York University Stern School of Business, he is considered one of the leading experts on the valuation of companies and assets.
Damodaran works intensively on the topic of country risk premiums and provides extensive data and models for calculating premiums for a large number of countries.
His current country-risk dataset was updated in January 2026. It provides, among other things, sovereign ratings, adjusted default spreads, country risk premiums, total equity risk premiums and, where available, sovereign CDS-based measures.
For the latest country-specific figures, please see Damodaran's Country Risk Premium dataset, as referenced earlier. The dataset should be referenced by valuation date because country-risk estimates change as market conditions change.
CRP in valuation practice
Country risks are particularly important in business valuation when a company operates in emerging or otherwise higher-risk markets.
The appropriate treatment depends on the valuation methodology. A valuer should distinguish between:
- Risk already reflected in the risk-free rate
- The mature-market equity risk premium
- The additional country risk premium
- The company’s actual exposure to that country risk
- Any other company-specific or cash-flow risk adjustments
This distinction is important because adding several risk adjustments that capture the same underlying risk can result in double-counting.
Country risk should therefore be documented together with the valuation date, source, calculation methodology and assumptions used to determine the company’s exposure.
International accounting standards such as IFRS also require valuation assumptions to reflect relevant market and company-specific risks in appropriate circumstances. For example, IAS 36 requires impairment testing to reflect risks relevant to the asset or cash-generating unit being tested.
Wrap it up!
The country risk premium is an important component of international business valuation. It reflects the additional return investors require for exposure to country-specific risks beyond those captured by a mature-market risk premium.
Determining the CRP is not simply a matter of adding an arbitrary percentage to the discount rate. A defensible calculation should identify the relevant country risk, select an appropriate methodology, use data corresponding to the valuation date and consider the company’s actual exposure to that risk.
Rating-based approaches, interest-rate differentials and broader country-risk models can all provide useful evidence. Damodaran’s methodology provides one established framework, combining sovereign default spreads with a mature-market equity risk premium and an adjustment for the higher volatility of equity markets.
The key is consistency. The CRP should be compatible with the selected risk-free rate, market risk premium, beta, currency and cash-flow assumptions. When these elements are aligned and properly documented, the country-risk adjustment becomes a transparent and defensible part of the business valuation.
Reference
- Damodaran, A. — Country Risk: Determinants, Measures and Implications – The 2026 Edition. NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html
- Damodaran, A. — Measuring Company Exposure to Country Risk: Theory and Practice. NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/valquestions/CountryRisk.htm
- Damodaran, A. — Country Risk Premiums. NYU Stern School of Business. This dataset provides country-specific equity risk premiums, country risk premiums, default spreads and related inputs. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/crryprem.htm
- IFRS Foundation — IAS 36 Impairment of Assets. Relevant where country-specific risks affect cash-flow forecasts, discount rates and impairment testing. https://www.ifrs.org/issued-standards/list-of-standards/ias-36-impairment-of-assets
Updated at 10 August 2026
