Thierry Senechal attended the International Bar Association (IBA) event in Roma as Member of the ICCA-ASIL Task Force on Damages. The focus of his presentation was on country risk and how to measure it.
Over the last decades, many frontier and emerging markets in Asia, Africa, South America, and Eastern Europe grew impressively. At the same time, these markets have shown high volatility in past years due to weak capital markets, unstable macroeconomic conditions, political risks, inefficient legal system, and so on. Commodity-driven economies are also more vulnerable.
First, Thierry Senechal addressed the question of risk diversification. Can one diversify the extra risk in an emerging market or not? He pointed out that finance theory clearly indicates the cost of capital should not reflect risk that can be diversified. He stressed that the main distinction between valuing companies in developed and emerging markets is the risk is greater in emerging markets. Not only it is more difficult to account for risks related to a company’s strategy, market position and industry dynamics in an emerging market, but there are usually greater risks caused by higher volatility in local capital markets, illiquidity of the banking sector, macroeconomic and political instability, and corruption. He argued that it is impossible to generalize, as risks differ from country to country and may affect businesses in myriad ways.
Finally, he discussed methods for assessing country risk. He argued that industry practitioners subscribe to different methods and often make arbitrary adjustments when assessing country risk, based on intuition and limited empirical evidence. Then, he provided a framework for measuring country risk and how to incorporate a country risk premium in valuation.