Country Risk: Drivers, Measures and Investment Implications - The 2026 Edition!

    I am a creature of habit in my personal and professional life, and in the context of the content that I post online, there is a ritual that I follow with my data updates. I start the year with my general data update online, and follow up with a series of posts where I examine the implications of this data for investing and corporate finance.  Since 2008, I have also done annual update papers on equity risk premiums in March of each year, with the link to the 2026 update here, and country risk in July of each year, where I look at the topics in more details, trying as best as I can to integrate the data, research and my own thinking. This year's country risk update paper is now available, and as in prior years, I will spend this post looking what causes risk to vary across countries, how to measure those risk variations and the implications for businesses and investors.

Country Risk: Relevance

  In my years as a business school student, country risk was given short shrift and I don't remember spending much time talking or thinking about it. Part of the reason was that business school education  was dollar-centric and built on the presumption that most graduates would go to work in New York, London or Tokyo, and have little need to confront country risk on a day-to-day basis. For those who raised country risk as an issue, the response was that you could, as a company or investor with global exposure, diversify it away. Both presumptions were wrong even then, and have become even more flawed over time as we have sold both companies and investors on the benefits of globalization.

    For businesses, the exposure to country risk comes from both the revenue side, as larger portions of every company's revenues come from foreign markets, and the cost side, as production gets outsourced to locales overseas. That exposure tends to increase as companies scale up, and is higher in some sectors than others; technology companies, for instance, get far more of their revenues from other non-domestic markets than manufacturing or service businesses. Outside of utilities (power, water), it is rare for a company to be entirely domestic-focused on both its revenue and cost sides. For investors, the initial draw of investing in foreign markets might have been diversification but the greater pull has come from greed, i.e., the belief that you can higher returns in the rest of the world. That process was accelerated by the creation of investment vehicles (index and mutual funds) that made investing overseas easier, the lowering of transactions costs across markets and a greater standardization of financial statements and disclosure across the globe. The home bias in portfolios, i.e., the skewing of portfolios towards domestic market investments, has not disappeared but it is lower than it was at the turn of the last century.

   The notion that country risk is diversifiable, i.e., that if you are operating or investing across the world, the risks will average out across countries, has been undercut by the increased correlation across global equity markets, and especially so during market crises (which is when you care the most).  At the risk of being hyperbolic, there is no place to hide from country risk, for either businesses or investors, and ignoring or dismissing country risk is not an option. I discovered this truth in the 1990s, when I found myself in need of a mechanism to incorporate country risk into my corporate financial analysis and valuations, and the process that you see described in this post was born from that need. I would hasten to add that the process that I describe has very little intellectual firepower behind it, puts pragmatism ahead of theory and most importantly is a work-in-process.

Country Risk: Drivers

    I don't think that there would be much disagreement, if I assert that it is riskier to invest in some parts of the world than others, but there is likely to be plenty of disagreement on why there are risk differences and which parts of the world are riskiest. In the broadest sense, I argue that variation in business risk across countries can be traced to four factors - the political structure of the country (democracy vs authoritarian), the prevalence of corruption in the country (operating as a hidden tax and distorting business outcomes), the extent of violence in the country (from internal and external forces) and the strength of the legal system in enforcing property rights and contractual obligations. 

    On the political risk front, I looked at the EIU's Democracy Index, a composite score measuring both political freedom and protections of civil liberties, with the caveat that any index that tries to measure these will make subjective judgements that not everyone will agree with. In their most recent update, here is what the EIU scores looked like around the world:

Source: Economist 
Low (High) score: Least (Most) freedom

Based on these scores, the tilt towards authoritarianism has increased over the last decade, with only 7.3% of the world's population living in democracies at the end of 2025. Note, though, that there is still an open question of whether businesses and economies do better under democratic than authoritarian regimes, and the answer in the research is at best a "maybe".  From a risk perspective, democratic regimes create more continuous risk for businesses, with elections bringing regulatory and rule changes to economies, than authoritarian regimes, where governments can promise more continuity in policy, but when change does come to the latter, it is more likely to be large and wrenching.

    

    Corruption is a fact of life in much of the world, and businesses often have no choice but to pay the price to survive and grow. Transparency International, a global coalition against corruption, tries to capture the extent of corruption, comes up with corruption scores for countries, with lower scores indicating less corruption, and the most recent edition contains the following:

Source: Transparency International
Low (High) score: Most (Least) corruption

Northern Europe has the lowest corruption scores, followed by Canada, United States and Australia, but large portions of Africa have high exposure to corruption, with Latin America and much of Asia falling in the middle. 

    Living in the midst of violence takes a toll, and that toll is extracted from businesses that try to operate in its presence. Vision of Humanity computes peace scores for countries, measuring exposure to both violence within the country as well as from wars and terrorism. The most recent peace scores are reported below:

Source: Vision of Humanity
Low (High) score: Most (Least) peaceful

Canada, Australia, Japan and much of Europe score high on the peace dimension, and while Latin America and Africa score lower, there are portions of each continent that are more peaceful. The Russia-Ukraine war has created a huge area of violence across Eastern Europe and Russia, and exposure to gun violence creates a drag on the United States.

    Businesses are dependent on the legal system  to enforce property rights as well as contractual obligations. Countries that have legal systems that are either capricious on these fronts, or hopelessly slow in acting, create challenges for businesses that operate in them, creating both costs and risks that they otherwise would not face. Property Rights Alliance is an entity that tracks international property rights across the world, and in their most recent update, their property rights scores by country are captured below:

Source: International Property Rights
Low (High) score: Least (Most) property rights

There are wide differences across regions, when it comes to legal and property rights, with Latin America, Africa and Asia lagging and Europe, Australia and much of North America leading. 

    There is one final dimension that I have added to country risk in recent years that captures exposure to climate risk. While there are many different entities that measure this exposure, each one with its own skews, the map below which shows the climate risk exposure, by country, from GermanWatch:

Source: GermanWatch
Low (High) score: Least (Most) affected

There are two reasons why climate risk has not become a bigger topic in country risk discussions. The first is that there is no part of the globe that is unaffected, making it less of a differentiator across countries on the risk dimension. The second is that climate risk, by itself, is an abstraction for businesses, until it starts affecting the bottom line, and while there are individual companies that are being impacted, the aggregate effects, at least at the moment, are not big enough to change the discussion. 

 Country Default Risk

    While country risk is determined by multiple factors, the challenge that businesses is  in consolidating all of those risks into one number. The market that does this most directly is the debt market, where, when countries (sovereigns) seek to borrow money, lenders determine the interest rates to charge them, based upon perceived default risk. To understand why lenders worry about default with sovereign debt, you can start by looking at the history of sovereign defaults in the graph below:

Source: BoC & BoE Sovereign Default Database

Debt defaults, which soared in the 1980s and 1990s, have been lower in this century, with a shift away from loan defaults (where banks are usually the lenders) to defaults in the bond market. It is also worth noting that a non-trivial portion of sovereign defaults in each year are local currency defaults, indicating that for some borrowers, the costs of defaulting are viewed as smaller than the costs of inflation arising from printing more currency to pay off debt. Over time, Latin America has been the epicenter for sovereign default, but at the end of 2023, sovereign debt in default had a wide geographical spread:

Source: BoC & BoE Sovereign Default Database

The most widely accessible measures of sovereign default risk remain sovereign ratings, with ratings agencies operating as (imperfect) arbiters. At the start of July 2026, the graph below reports the sovereign ratings for all rated countries, from S&P, Moody's and Fitch:

Source: Multiple public sources

As you can see, the ratings agencies mostly agree on their assessments of default risk, and sovereign ratings are correlated with the risk drivers (politics, corruption, violence, legal system) that we outlined in the last section. I do believe that ratings agencies, notwithstanding the critiques of bias and mis-measurement leveled against them, do a reasonably good job in their ratings assessments, but they are often slow to act, when confronted with change. 

    The sovereign CDS market offers a market-based alternative for measuring sovereign default risk, with investors making assessments of how much they would demand to insure against sovereign default in the form of (annualized) spreads. In the graph below, I list 10-year sovereign CDS spreads as of July 1, 2026:

Source: Bloomberg

Note that sovereign CDS spreads are available for only 84 countries, and that there are swaths of the world (Central and North Africa, frontier markets) where they are not available. 

Country Composite Risk

    When you lend money to governments or buy government bonds, sovereign default risk is your key concern, and both sovereign ratings and CDS spreads try to measure that risk. When running a business in a country, you are exposed to a much wider range of risks, and measuring exposure to those risks may require different measures. One alternative is country risk scores, where services evaluate how  countries measure up on different risk drivers, and come up with composite scores for these countries. In the table below, I report the country risk scores from two services - Political Risk Services (PRS) and the Economist (EIU), at the start of July 2026:

Sources: EIU (Economist) and PRS

The table illustrates three problems that you face with political risk scores. The first is that the scoring is idiosyncratic, with the Economist going from low scores for the safest countries to high scores for the riskiest, and PRS doing the reverse. The second is that each service picks different factors to consider, and different weightings, leading to scoring divergences that sometimes confound; PRS, for instance, ranks the United States as riskier than Ghana, on a composite risk basis. The third is that the scores, by themselves, are difficult to convert into inputs in financial analysis, either in cash flow or discount rate adjustment.

   It is to combat the third problem that I started estimating country equity risk premiums, and while the details of the process and the data that I use have changed over the last three decades, the basic structure has remained unchanged. I start with an estimate of the equity risk premium for a mature market, and build a country risk premium, if needed, for riskier countries. Until 2025, I estimated the mature market premium by computing an implied equity risk premium for the S&P 500, and using that as the base, arguing that the US, as a Aaa rated country (at least according to Moody's), represented a mature market. The Moody's downgrade for the US, from Aaa to Aa1, has thrown a wrench into that approach, requiring adaptation. In response, I now start with an estimate of the implied ERP for the S&P 500, but then adjust that estimate for the default spread (based on the Aa1 rating) for the US, with the resulting values at the start of July 2026 below:

Spreadsheet: https://pages.stern.nyu.edu/~adamodar/pc/implprem/ERPJuly26.xlsx

As you can see, with the S&P 500 at 7499.36 on July 1, 2026, the implied equity risk premium for the United States is 4.42%, and netting out the default spread of 0.22% for the Aa1 rating yields a mature market premium of 4.20%.

    To estimate country risk premiums, I start with the sovereign ratings for rated countries and convert those ratings into default spreads. To adjust for the higher risk associated with equities, relative to government bonds, I estimate a composite measure of that relative risk, by scaling the volatility in an emerging market equity index to the volatility in a emerging market government bond ETF, and scale the default risk up with this relative risk measure (1.55 in July 2026) to get country risk premiums:

For the two dozen countries that have no sovereign ratings, I adopt an even more makeshift approach, where I used political risk scores for these countries, and then looked for rated countries with similar scores. The table below has equity and country risk premiums, by country, for all of the countries that I evaluated in July 2026:

Download data

I did post an earlier version of this table a couple of weeks ago, but the numbers that I reported reflected in incomplete update of sovereign default spreads, and this table (and the data on my webpage) now reflect the corrected (and lower) spreads. (As a solo act, I am deeply grateful for the checking that those who use my data do, and thankful when they point out mistakes that I have made.)

Company Exposure to Country Risk

    If you buy into my argument that every company has a narrative, and it is the narrative that drives its value, it is worth considering where country risk fits into that narrative. The answer, I believe, comes from looking at where the country in question falls in the life cycle:

The message from this life cycle view is a sobering one, especially for those analyzing companies that operate in very risky countries, since the narratives for these companies implicitly or explicitly incorporate a country risk component. You cannot value a Venezuelan company without taking a strong view about Venezuela, or even an Indian and Brazilian company without an India or Brazil country story underpinning value. In contrast, you may be able to value US and European companies, without explicitly considering the evolution of country risk in those parts of the world.

    When looking at an individual company, I believe that country risk exposure comes less from where the company is incorporated and more from where it operates. It is undeniable that companies around the world have substantial exposure outside their domestic markets, and that exposure has increased over time. In the graph below, I look at the revenue breakdown of companies in four indices - the S&P 500 (US), the FTSE 100 (UK), the Nikkei 225 (Japan) and the Sensex (India):

    

In every single index, companies that comprise that index get a significant portion of their revenues from outside the domestic market. Looking across sectors, exposure to foreign markets varies widely with technology companies often generating more than half of their revenues outside their domestic settings. I believe that equity risk premiums for companies should reflect exposure to foreign markets, though it is worth debating how best to weight that exposure - revenues work well for consumer product and service companies, production works better for natural resource companies and a mix of revenues and production may be the right choice for manufacturing companies:

With this framework, you can see why almost all analysts will confront country risk, sooner or later, no matter where they operate in the world and which companies they analyze. 

    For companies, country risk will also come into play when faced with capital budgeting decisions, where they need estimates of hurdle rates for individual projects, to decide where to invest. For a multinational operating in many businesses, the project cost of equity will have to then also reflect the business the project is in, in addition to country risk. Thus, the cost of equity for a Siemens Appliances for a project in India should reflect the beta for the appliance business, in addition to the country risk for India. In contrast, a Siemens power tool project in Hungary should be computed using the beta for an power tools project and the country risk for Hungary. It is also possible that country risk is not easy to isolate, if the production facilities are in one country but revenues are generated in another. If the Siemens appliance factory in India will be producing products that will be sold in Japan, should we be showing the country risk of India or Japan in the cost of equity calculation? The answer, as was the case in the earlier section on valuation, is that it depends on where the company sees risk coming from. If the risk is that production will be delayed or disrupted by political and economic risk in India, it is Indian country risk that should be looked at, but if the primary concern is that revenues in Japan will be volatile because of economic conditions there, it is Japanese country risk that matters more. If both risks are considerations, you should use a weighted average of Indian and Japanese country risk.

Currency Questions

    For some of you, it may seem odd that I have spent almost an entire post talking about country risk without bringing up currencies. The reason is simple. Currencies are measurement mechanisms, and while they may be affected by the same political and economic factors that drive country risk, they don't determine country risk and in my view, should not command risk premiums, on their own. 

    It is true that hurdle rates are affected by both the equity risk premiums that you estimate and the riskfree rate that you use, and that riskfree rates vary across currencies. In the figure below, I estimate riskfree rates in about 40 currencies, where a local-currency government bond rate is present, and I adjust that government bond rate for the default risk of the government in question:

When estimating the cost of equity for a Turkish project or company in Turkish lira, we start with a riskfree rate in excess of 20% and build on it, by adding equity risk premiums to it, but the cost of equity for the same project or company in Euros will begin with a riskfree rate close to 3% (the German Euro bond rate) and arrive at a much lower number. While this may sound farfetched, the value that you derive for the project or company should be the same using either currency, if you are consistent about estimating your cash flows in the same currency:

Since much or almost all of the differences in riskfree rates come from inflation differentials, matching the high Turkish lira discount rate with a high growth in cashflows in Turkish lira, and the low Euro discount rate with the low growth in cashflows estimated in Euros will yield results that are consistent.

    If you do want to estimate riskfree rates in currencies where there is either no local currency government bond that is traded or where you mistrust the government bond rate, because of light trading or government intervention, the fact that riskfree rate differences across currencies can be tied to differential inflation can be used for estimation; the riskfree rate in any currency can be computed from a base currency (dollar or Euro) riskfree rate and the difference in expected inflation between the local and base currencies:

Put simply, if the expected inflation rate and riskfree rate in US dollars are 2.5% and 4% respectively, and the expected inflation rate in Brazil is 10.5%, the riskfree rate in Brazilian reais should be roughly 12%. The implication of this approach is that currency pegs, when they do exist, will hold only if the inflation in the pegged currency matches or is close to the inflation in the index currency to which it is pegged. It is true that the estimates of riskfree rates will only be as good as the expected inflation rates that are embedded in the estimation, but the good news is that being wrong on expected inflation will be largely offsetting, since both your cashflows and your discount rates will be wrong in the same direction; if you underestimate expected inflation, you will underestimate (overestimate) your riskfree and hurdle rates, but you will also underestimate (overestimate) your expected growth rate in cash flows.

Conclusion

   One of the side effects of the rise of globalization is that there are fewer and fewer companies that are entirely local-country focused in both their revenues and production, and as a result, almost every business and investor is exposed to risk in other parts of the world. The problem with measuring country risk is that while its consequences are economic, it has its sources in history, politics and governance structures. The measures of country risk, whether they be entity-based like sovereign ratings, or market estimates like sovereign CDS spreads, reflect this interplay.

    I confess that I have made simplistic assumptions and cut corners in my attempt to estimate equity risk premiums, by country, and there will be individual countries, perhaps even your own, where you might disagree with my assessments. As I noted earlier, my estimation approach remains a work-in-progress and I am always open to suggestions on how to estimate these premiums better, but keep in mind that whatever those improvements may be, they will have to work across 180 countries. 

YouTube Video

Papers on country risk and equity risk premiums

1. Country Risk Premiums - The 2026 Edition (July 2026)
2. Equity Risk Premiums - The 2026 Edition (March 2026)

Data

1. Equity Risk Premiums, by country - July 2026
2. Implied Equity Risk Premiums for the S&P 500 (Annual since 1960 & Monthly since Sept 08)
3. Inflation-based riskfree rates, by currency - July 2026

Spreadsheet

1. Implied ERP for S&P 500 (July 2026)

Data Update 4 for 2026: The Global Perspective!

    If you have read my first three data updates in 2026, I won’t blame you if you skip this one, because you found them long and boring. I won't take issue with you either if you viewed them as too US-focused, because I did spend my second data update, looking at US equities, and my third, examining US treasuries and the US dollar. In this post, I widen my data analysis to look at the rest of the world, starting with a journey through global equity markets in 2025, moving on to creating a snapshot of country risk at the start of 2025 and finishing by looking at interest rate differences across currencies. Along the way, I will argue for a larger narrative, underlying this global perspective. I am not a political or a macroeconomic analyst, but I attribute much of what we have seen in terms of global politics and economics in the last four decades, first to the rise of globalization as an almost unstoppable force, shaping immigration and economic policies in much of the world, and then, in most recent years, to a backlash against the same forces. That backlash has not only upended the political order in the developed world, with both Europe and the United States seeing changes in power structure, but also brought nationalist parties to power in many emerging market countries. From investing and business perspectives, we saw the effects play out strongly in 2025, and I don't think that this genie is going back into the bottle.

Global Equties in 2025

    In my second data update, I noted that US equities had a good year in 2025, delivering a return of 17.72% for the year, but the US dollar weakened in 2025, down a bit more than 7% during the year. I started my exploration of global equities by looking at the returns in local currency terms of equity indices in different parts of the world:

 

In each region, I have highlighted the best performing index (in green) and worst performing one (in red), and you can see the disparities in market performance, even within regions. One of the problems with comparing returns across currencies is that they are distorted by the effects of inflation that also vary widely across currencies. While I will look at inflation differences in more detail later in this post, one way to make the returns comparable is to recompute them in a common currency. To this end, I compute the dollar returns, in aggregate dollar market capitalization terms, in 2025:

As I mentioned in my second data update, India was the worst performing sub-region of the world, up only 3.31% in 2025, and those returns reflect not just a relatively below-average year in local currency terms, with the Sensex up 8.55% for the year, but a weaker currency, with the rupee depreciating against the dollar. It is only one year and while I will need read too much into it, my argument earlier last year that the India story has legs, but that the path to delivering it will be rockier than many of its advocates seem to thing. For much of the rest of the world, the dollar returns are higher than local currency returns, because of currency appreciation against the dollar.

    Zeroing in on the aggregate market capitalization across the world at the start of 2026, I first created a pie chart (on the left)  breaking market capitalization by region, and as you can see, US equities, in spite of a weaker dollar, accounted for 47% of global market capitalization.

Evaluating just the change in market capitalization during 2025, in the second pie (not he right), you can see the reason for the slippage in the US hare, with the US punching in below its weight (38% of the change) and Europe and China weighing in, with larger shares. 

  To close this section, I will unwrite an epitaph for international diversification that many US investors, wealth advisors and market experts were starting to etch in stone even a year ago. For much of the twenty first century, an investor invested entirely in US stocks would have outperformed one who followed the textbook advice to diversify globally. While that may look sound conclusive, the truth is that two decades is not a long time period in stock market history and that you can have extended market runs that look permanent, even when they are not. It is true that as multinationals displace domestic companies, the payoff to international diversification has become smaller over time; buying the S&P 500 would have bought your exposure to the global economy, since the companies in the index, while incorporated in the US, get almost 60% of their revenues in the rest of the world. However, the underperformance of the US, relative to the rest of the world, in 2025 should be a reminder that international diversification still belongs in the toolkit for a prudent investor. That lesson cuts across the globe, and suggests that much as politicians and countries may want to delink from each others, investors don't have that choice.

Country risk in 2025

    If you have been a reader of my posts, I do have a bit of an obsession with country risk,, i.e., why the risk of investing and doing business varies across countries, and what causes that risk to change. My defense for that is that I teach corporate finance and valuation, and to do either, I need answers to these country risk questions, and while you may not like the short cuts and approximations I use along the way, I will take you along on my January 2026 journey:

    The place to start any discussion of country risk is with an examination of the factors that feed into that risk, and I will use a matrix that you may have seen in my prior posts on country risk:

While I do take a deeper and more detailed look at these factors in a mid-year update that I do every year (links to paper and my July 2025 blog post), the forces that cause differences in country risk span politics and economics, and include:

1. Political Structure: From an investing and business standpoint, the choice between democracy and autocracy is nuanced, with the former creating more continuous uncertainty, as changes in government bring more policy change , and the latter creating more policy stability in the near term, albeit with a greater likelihood for wrenching and potentially catastrophic uncertainties over time.
2. War and Violence: Investing and business become more hazardous, both physically and economically, if you invest in a more violent setting, and war, terrorism and access to weapons can create differences across countries.
3. Corruption: Corruption affects businesses directly, operating as implicit taxes on businesses that are exposed to it, and indirectly, by undercutting trust and the willingness to follow rules. While differences in corruption across countries are often attributed to cultural factors, a significant component of corruption comes from structures that are designed to encourage and reward it.
4. Legal and Property rights: Investors and businesses are dependent on contracts and legal agreements to operate, but protection for property rights. Legal systems that are capricious in how they enforce contractual and ownership rights, or delay judgments to make them effectively useless, create risks for businesses and investors.

There are many reasons to expect differences across countries, on these dimensions, there is a different perspective that can also help. As some of you may know, I look at businesses through the lens of a corporate life cycle, where as businesses age, their characteristics and challenges change as well. That life cycle structure can be used to explain differences across countries, where the age is less tied to how long a country has been in being and more to do with its economy.

Young economies have higher growth potential, but that higher economic growth comes with more risk (more volatile economies) and require more robust governance to deliver on their promise. As economies age, they face a period of lower growth, albeit with more economic stability, and governance matters less, effectively become mature (middle aged) economies. There is a final phase, where a country’s economy hits walls, and growth can stagnate or even become negative, driven partly by a loss of competitive edge and partly by aging populations. In each of these phases, countries often overreach, with young countries aspiring for the stability of middle age, while trying to grow at double-digit rates, and mature companies, seeking to rediscover high growth. Without treading too much on political terrain, it may be worth thinking about the Trump actions in 2025 as driven, at least partially, by nostalgia for a different time, when the United States was the dominant economic power, with a combination of solid economic growth and stability that few economies, almost unmatched in history.

    With that philosophical discourse in country risk out of the way, let’s turn to the brass tacks of measuring country risk, starting with one of the most accessible and widely available one, which are ratings that agencies such as S&P, Moody’s and Fitch (among others) attach to sovereigns. The following is the heatmap of sovereign ratings (from Moody’s) at the start of 2026:

While Moody’s rates more than 140 countries, there remain a few (called frontier markets) that have no ratings, but in terms of the color map, I have included those countries with the lowest rated, because they share many of the same risk characteristics. There are three key features of these ratings that are worth emphasizing:

1. The sovereign ratings are focused almost entirely on default risk, and while the chance that a country will default is correlated with the core risks (violence, political structure, legal system and corruption) that I mentioned up front, there are countries on this list where they diverge. I believe that this is especially the case in the Middle East, where there are countries, like Saudi Arabia, that have low or no default risk, but remain exposed to large political risks.
2. The sovereign ratings have their share of biases, for or against regions, but their bigger sin is that they are slow to react. If you look at the list, you will see countries like Argentina and Venezuela that have seen significant changes in governance and politics in the last year, but where the ratings have not changed or barely changed. That will probably change in 2026, but this delayed response will mean that the sovereign ratings for some countries, at least, will not be good reflections of country risk, at the moment.
3. There were a few ratings changes in 2025, mostly at the margin, but the one that got the most attention was the ratings downgrade for the US that I highlighted at the time it happened. While markets, for the most part, took that ratings downgrade in stride, it did create waves in the process that I use to estimate riskfree rates and equity risk premiums, by country, as you will see later in this post.

The reason that so much of how we deal with country risk rests on sovereign ratings is not because ratings agencies have special insights, but because sovereign ratings, unlike other (often more comprehensive) measures of country risk, like country risk scores (from PRS or the Economist, to name two), can be converted into default spreads that conveniently feed into financial analysis. At the start of 2026, here are my estimates of default spreads for each sovereign rating:

As I noted earlier though, using sovereign ratings to get default spreads comes with the limitations that these ratings may not reflect current conditions, when change is rapid, and that is where the sovereign CDS market has created an alternative. For the 80 countries where sovereign CDS exist, you can get a market-determined number for the default spread, and here are the numbers at the start of 2026:

Note that these spreads, while noisy and reflective of market mood, reflect the world we live in, and both Argentina and Venezuela, which used to be uninsurable, have both seen improvement on these market-driven numbers, albeit from impossible to insure to really costly to insure.

    As a final step in my country risk exploration, I repeat a process that I have used to estimate equity risk premiums, by country, every six months for close to three decades. That process starts with estimating an equity risk premium for the S&P 500, and then uses the country default spreads (based upon the ratings) to estimate equity risk premiums for countries:

It is undeniable that the ratings downgrade for the US has created some change in this process. Instead of using the S&P 500’s implied equity risk premium as my estimate of the mature market premium, which was my pathway until May 2025, I now remove the default spread (0.23%) for the US from that premium to get to a mature market equity risk premium (4.23%). To get to country risk premiums for individual countries, I scale up the ratings-based default spreads for the relative riskiness of equities, and add these country risk premiums to the mature market premium:

Download equity risk premiums, by country

Note that I bring the frontier countries into the mix, by using country risk scores for these countries to estimate country and equity risk premiums. 

The Currency Effect

    While it remains true that country risk and currency volatility/devaluation often go together, one of my concerns with mixing up the two up is that you end up double counting or miscounting risk. To understand the divide between country and currency risk, I start with a look at government bond rates in different currencies, with the caveat that there only about forty governments that issue bonds in their local currencies and that some or many of these government bonds are lightly traded, making their rates unreliable.

In many finance classes and textbooks, you are often taught (as I was) to use the government bond rate as the riskfree rate, on the facile assumption that governments should not default on these bonds, since they can print more currency and cover their debt obligations. The problem with that logic is that it is at odds with the reality that governments can, and often do, default on local currency bonds, choosing that option over devaluation. That also means that the government bond rates can include a default risk component, and to get to a riskfree rate, that default risk needs to be removed from the government bond rate. In the picture above, that is what I do, using the ratings-based default spread). After this clean-up, you can see that riskfree rates vary widely across currencies, from very low in some currencies (Swiss Franc, Japanese yen and the Thai Baht), slightly higher for others (US dollar, Euros) and very high on a few (Turkish Lira, Zambian kwacha). 

    In my third data update, I estimated an intrinsic riskfree rate for the US dollar, by adding inflation and real GDP growth. Extending that lesson to other currencies, the primary reason for differences in these riskfree rates, across currencies, is expected inflation, with higher(lower) interest rates in higher (lower) inflation currencies. While inflation measures are imperfect and expected inflation estimates are often flawed, I use the IMF’s estimates of inflation to build a global inflation heat map:

The logic that I used to argue that it is unlikely that you will see US treasury bond rates drop much below 4%, at least as long as inflation runs hot (2.5-3%), not only applies for other currencies, but yields a roadmap for estimating riskfree rates in those currencies (including those without a government bond in the local currency). To illustrate, I will try to estimate an Egyptian pound riskfree rate at the start of 2026:

Riskfree rate in local currency = Riskfree rate in US dollars + (Expected inflation rate in local currency – Expected inflation in US $)

Thus, the riskfree rate in Egyptian pounds, using the expected inflation rates of 7.78% for Egypt and 2.24% for the United States is 9.49%:

          Riskfree rate in US dollars = US T.Bond rate - US default spread = 4.18% -0.23% = 3.95%

Riskfree rate in EGP (1/1/26) = Riskfree rate in US $ + (Expected inflation in Egypt – Expected inflation in US) = 3.95% + (7.78% - 2.24%) = 9.49%

Note that the riskfree rate in US $ is 3.95%, obtained by cleansing the US 10-year treasury rate on January 1, 2026 (4.18%) of US default risk (0.23%). The estimate for a riskfree rate is an approximation is an approximation, since inflation rates compound, and that compounded version is below:

Riskfree rate in EGP = (1+ US $ Riskfree Rate) × (1 + Expected inflation rate in EGP)/ (1+ Expected inflation rate in US $) -1 = 1.0395 × (1.0778/ 1.0224) -1 = .0958 or 9.58%

I have used IMF inflation rates to get riskfree rates in almost all global currencies in this link, but I don’t blame you, if you are skeptical about the expected inflation numbers. From a financial analysis and valuation perspective, I have good news and it is that it does not matter if you are wrong on inflation, if you are consistently so (in both your earnings and cash flows as well as your discount rates).

Put simply, the effects of expected inflation in valuation cancel out, and that is that the basis of what I would term “the currency invariance theorem”, where the value of a project or company should not change, if you change the currency in which you do your analysis. A project that has a positive NPV, when the analysis is done in US $, should continue to have the same positive NPV, if you redo the analysis in EGP, and a company that is overvalued, when the valuation is in US $, will remain overvalued, if you revalue it in EGP. The currency you chose to do an analysis is cannot alter the underlying value but that does not mean that changes in inflation cannot change the values of businesses, since that effect will depend on how well a company can pass inflation through to its customers (with pricing power), and I examined that relationship in 2022, after inflation had a resurgence in the United States after a decade of being low and boring. 

Thus, high inflation in Turkish lira has undoubtedly wreaked havoc the value of some Turkish companies, but given that damage, my point is that revaluing these companies in Euros will not undo that damage.

The Bottom Line

   As globalization gets a blowback, and in the midst of turmoil from tariffs, we got a reminder of how, much as we may want to go back to simpler times where the rest of the world did not intrude into our lives, we are all connected in good and bad ways. Thus, you may disagree with me on how to measure country risk and to bring into your analysis and investments, but it is undeniable that risk varies across countries and that we must incorporate that risk into our decision making. I hope that this post expose the layers in the process from the drivers of country risk to how these drivers play out as differences in country ratings, default spreads and equity risk premiums, while illustrating th how country risk can change over time, and sometimes in short periods.

YouTube Video

Datasets

1. Equity risk premiums by country at the start of 2026
2. Differential-inflation riskfree rates, by currency, at the start of 2026

Data Update Posts for 2026

1. Data Update 1 for 2026: The Push and Pull of Data
2. Data Update 2 for 2026: Equities get tested and pass again!
3. Data Update 3 for 2026: The Trust Deficit - Bonds, Currencies, Gold and Bitcoin!
4. Data Update 4 for 2026: The Global Perspective
5. Data Update 5 for 2026: Risk and Hurdle Rates
6. Data Update 6 for 2026: In Search of Profitability
7. Data Update 7 for 2026: Debt and Taxes
8. Data Update 8 for 2026: Dividends and Buybacks

Country Risk 2025: The Story behind the Numbers!

    At the start of July, I updated my estimates of equity risk premiums for countries, in an semiannual ritual that goes back almost three decades. As with some of my other data updates, I have mixed feelings about publishing these numbers. On the one hand, I have no qualms about sharing these estimates, which I use when I value companies, because there is no secret sauce or special insight embedded in them. On the other, I worry about people using these premiums in their valuations, without understanding the choices and assumptions that I had to make to get to them. Country risk, in particular, has many components to it, and while you have to ultimately capture them in numbers, I wanted to use this post to draw attention to the many layers of risk that separate countries. I hope, and especially if you are a user of my risk premiums, that you read this post, and if you do have the time and the stomach, a more detailed and much longer update that I write every year.

Country Risk - Dimensions

    When assessing business risk from operating in a country, you will be affected by uncertainty that arises from almost every source, with concerns about political structure (democracies have very different risk profiles than authoritarian regimes), exposure to violence (affecting both costs and revenues),  corruption (which operates an implicit tax) and legal systems (enforcing ownership rights) all playing out in business risk.

I will start with political structure, where the facile answer is that it less risky to operate a business in a democracy than in an authoritarian regime, but where the often unpalatable truth is that each structure brings its own risks. With democracies, the risk is that newly elected governments can revisit, modify or discard policies that a previous government have adopted, requiring businesses to adapt and change to continuous changes in policy. In contrast, an authoritarian government can provide long term policy continuity, with the catch being that changes in the government, though infrequent, can create wrenching policy shifts that businesses have to learn to live with. Keeping the contrast between the continuous risk of operating in a democracy and the discontinuous risk in an authoritarian structure in mind, take a look at this picture of how the world looked in terms of democracy leading into 2025:

Source: Economist Intelligence Unit (EIU)

It is worth noting that there are judgment calls that the Economist made in measuring democracy that you and I might disagree with, but not only is a large proportion of the world under authoritarian rule, but the trend lines on this dimension  also have been towards more authoritarianism in the last decade.    

    On the second dimension, exposure to violence, the effects on business are manifold. In addition to the threat that violence can affect operations, its presence shows up as higher operating costs (providing security for employees and factories) and as insurance costs (if the risks can be insured). To measure exposure to violence, from both internal and external sources, I draw on measures developed and updated by the Institute of  Economics & Peace across countries in 2024:

Institute of Economics & Peace

The Russia-Ukraine war has caused risk to flare up in the surrounding states and the Middle East and central Africa continue to be risk cauldrons, but at least according to the Institute's measures, the parts of the world that are least exposed to violence are in Northern Europe, Australia and Canada. Again, there are judgments that are made in computing these scores that will lead you to disagree with specific country measures (according the Peace Institute, the United States and Brazil have higher exposures to violence than Argentina and Chile, and India has more exposure to violence than China), but the bottom line is that there are significant differences in exposure to violence across the world.

    

    Corruption is a concern for everyone, but for businesses, it manifests in two ways. First, it puts more honest business operators at a disadvantage in a corrupt environment, since they are less willing to break the rules and go along with corrupt practices than their less scrupulous competitors. Second, even for those businesses that are willing to play the corruption game, it creates costs that I would liken to an implicit tax that reduces profits, cash flows and value. The measure of corruption that I use comes from Transparency International, and leading into July 2025, and the heat map below captures corruption scores (with higher scores indicating less corruption), as well as the ten most and least corrupt countries in the world: 

Transparency International

As you can see from the map, there are vast swaths of the world where businesses have to deal with corruption in almost every aspect of business, and while some may attribute this to cultural factors, I have long argued that corruption almost inevitably follows in bureaucratic settings, where you need licenses and approvals for even the most trivial of actions, and the bureaucrats (who make the licensing decisions) are paid a pittance relative to the businesses that they regulate. 

    

    As a final component, I look at legal systems, especially when it comes to enforcing contractual agreements and property rights, central to running successful businesses. Here, I used estimates from the IPRI, a non-profit institution that measures the quality of legal systems around the world. In their latest rankings from 2024, here is how countries measured up in 2024:

Property Rights Alliance

In making these assessments, you have to consider not just the laws in place but also the timeliness with which these laws get enforced, since a legal system where justice is delayed for years or even decades is almost as bad as one that is capricious and biased. 

Country Risk - Measures

    The simplest and most longstanding measure of country risk takes the form of sovereign ratings, with the same agencies that rate companies (S&P, Moody's and Fitch) also rating countries, with the ratings ranging from Aaa (safest) to D (in default). The number of countries with sovereign ratings available on them has surged in the last few decades; Moody’s rated 13 countries in 1985, but that number increased to 143 in 2025, with the figure below listing the number of rated countries over time:

Note that that the number of Aaa rated countries stayed at eleven, even while more countries were rated, and has dropped from fifteen just a decade ago, with the UK and France losing their Aaa ratings during that period. In May 2025, Moody's downgraded the United States, bringing them in line with the other ratings agencies; S&P downgraded the US in 2011 and Fitch in 2023. The heat map below captures sovereign ratings across the world in July 2025:

Moody's

While sovereign ratings are useful risk measures, they do come with caveats. First, their focus on default risk can lead them to be misleading measures of overall country risk, especially in countries that have political risk issues but not much default risk; the Middle East, for instance, has high sovereign ratings. Second, the ratings agencies have blind spots, and some have critiqued these agencies for overrating European countries and underrating Asian, African and Latin American countries. Third, ratings agencies are often slow to react to events on the ground, and ratings changes, when they do occur, often lag changes in default risk.

    If you are leery about trusting ratings agencies, I understand your distrust, and there is an alternative measure of sovereign default risk, at least for about half of all countries, and that is the sovereign credit default swap (CDS) market, which investors can buy protection against country default. These market-determined numbers will reflect events on the ground almost instantaneously, albeit with more volatility than ratings. At the end of June 2025, there were about 80 countries with sovereign CDS available on them, and the figure below captures the values:

The sovereign CDS spreads are more timely, but as with all market-set numbers, they are subject to mood and momentum swings, and I find using them in conjunction with ratings gives me a better sense of sovereign default risk.

    If default risk seems like to provide too narrow a focus on countr risk, you can consider using country risk scores, which at least in principle, incorporate other components of country risk. There are many services that estimate country risk scores, including the Economist and the World Bank, but I have long used Political Risk Services (PRS) for my scores.. The PRS country risk scores go from low to high, with the low scores indicative of more country risk, and the table below captures the world (at least according to PRS):

Political Risk Services (PRS)

There are some puzzling numbers here,  with the United States coming in as riskier than Vietnam and Libya, but that is one reason why country risk scores have never acquired traction. They vary across services, often reflecting judgments and choices made by each service, and there is no easy way to convert these scores into usable numbers in business and valuation or compare them across services.

    

Country Risk - Equity Risk Premiums

    My interest in country risk stems almost entirely from my work in corporate finance and valuation, since this risk finds its way into the costs of equity and capital that are critical ingredients in both disciplines. To estimate the cost of equity for an investment in a risky country. I will not claim that the approaches I use to compute equity risk premiums for countries are either original or brilliant, but they do have the benefit of consistency, since I have used them every year (with an update at the start of the year and mid-year) since the 1990s. 

    The process starts with my estimate of the implied equity risk premium for the S&P 500, and I make this choice not for parochial reasons but because getting the raw data that you need for the implied equity risk premium is easiest to get for the S&P 500, the most widely tracked index in the world. In particular, the process requires data on dividends and stock buybacks on the stocks in the index, as well as expected growth in these cash flows over time, and involves finding the discount rate (internal rate of return) that makes the present value of cash flows equal to the level of the index. On June 30, 2025, this assessment generated an expected return of 8.45% for the index:

Download ERP spreadsheet

Until May 2025, I just subtracted the US 10-year treasury bond rate from this expected return, to get to an implied equity risk premium for the index, with the rationale that the US T.Bond rate is the riskfree rate in US dollars. The Moody’s downgrade of the US from Aaa to Aa1 has thrown a wrench into the process, since it implies that the T.Bond rate has some default risk associated with it, and thus incorporates a default spread. To remove that risk, I net out the default spread associated with Aa1 rating from the treasury rate to arrive at a riskfree rate in dollars and an equity risk premium based on that:

Riskfree rate in US dollars       = T.Bond rate minus Default Spread for Aa1 rating

                                                            = 4.24% - 0.27% = 3.97%

Implied equity risk premium for US = Expected return on S&P 500 minus US $ riskfree rate

                                                            = 8.45% - 3.97% = 4.48%

Note that this approach to estimating equity risk premiums is model agnostic and reflects what investors are demanding in the market, rather than making a judgment on whether the premium is right or what it should be (which I leave to market timers).

       To get the equity risk premiums for other countries, I need a base premium for a mature market, i.e., one that has no additional country risk, and here again, the US downgrade has thrown a twist into the process. Rather than use the US equity risk premium as my estimate of the mature market premium, my practice in every update through the start of 2025, I adjusted that premium (4.48%) down to take out the US default spread (0.27%), to arrive at the mature market premium of 4.21%. That then becomes the equity risk premium for the eleven countries that continue to have Aaa ratings, but for all other countries, I estimate default spreads based upon their sovereign ratings. As a final adjustment, I scale these default spreads upwards to incorporate the higher risk of equities, and these become the country risk premiums, which when added to the mature market premium, yields equity risk premiums by country. The process is described below:

The results from following this process are captured in the picture below, where I create both a heat map based on the equity risk premiums, and report on the ratings, country risk premiums and equity risk premiums, by country:

Download equity risk premium, by country

If you compare the equity risk premium heat map with the heat maps on the other dimensions of country risk (political and legal structures, exposure to violence and corruption), you will notice the congruence. The parts of the world that are most exposed to corruption and violence, and have capricious legal systems, tend to have higher equity risk premiums. The effects of the US ratings downgrade also manifest in the table, with the US now having a higher equity risk premium than its Aaa counterparts in Northern Europe, Australia and Canada.

A User's Guide 

    My estimates of equity risk premiums, by country, are available for download, and I am flattered that there are analysts that have found use for these number. One reason may be that they are free, but I do have concerns sometimes that they are misused, and the fault is mine for not clarifying how they should be used. In this section, I will lay out steps in using these equity risk premiums in corporate finance and valuation practice, and  if I have still left areas of  grey, please let me know.

Step 1: Start with an understanding of what the equity risk premium measures

    The starting point for most finance classes is with the recognition that investors are collectively risk averse, and will demand higher expected returns on investments with more risk. The equity risk premium is a measure of the “extra” return that investors need to make, over and above the riskfree rate, to compensate for the higher risk that they are exposed to, on equities collectively. In the context of country risk, it implies that investments in riskier countries will need to earn higher returns to beat benchmarks than in safer countries. Using the numbers from July 2025, this would imply that investors need to earn 7.46% more than the riskfree rate to invest in an average-risk investment in India, and 10.87% more than the riskfree rate to invest in an average risk investment in Turkey.

    It is also worth recognizing how equity risk premiums play out investing and valuation. Increasing the equity risk premium will raise the rate of return you need to make on an investment, and by doing so, reduce its value. That is why equity risk premiums and stock prices move inversely, with the ERP rising as stock prices drop (all other thins being held constant) and falling as stock prices increase. 

Step 2: Pick your currency of analysis (and estimate a riskfree rate)

    I start my discussions of currency in valuation by positing that currency is a choice, and that not only can you assess any project or value any company in any currency, but also that your assessment of project worth or company value should not be affected by that choice. Defining the equity risk premium as the extra return that investors need to make, over and above the risk free rate, may leave you puzzled about what riskfree rate to use, and while the easy answer is that it should be the riskfree rate in the currency you chose to do the analysis in, it is worth emphasizing that this riskfree rate is not always the government bond rate, and especially so, if the government does not have Aaa rating and faces default risk. In that case, you will need to adjust the government bond rate (just as I did with the US dollar) for the default spread, to prevent double counting risk.  

Staying with the example of an Indian investment, the expected return on an average-risk investment in Indian rupees would be computed as follows:

Indian government bond rate on July 1, 2025 = 6.32%

Default spread for India, based on rating on July 1, 2025 = 2.16%

Indian rupee risk free rate on July 1, 2025 = 6.32% - 2.16% = 4.16%

ERP for India on July 1, 2025 = 7.46%

Expected return on average Indian equity in rupees on July 1, 2025 = 4.16% + 7..46% = 11.62%

Note also that if using the Indian government bond rate as the riskfree rate in rupees, you would effectively be double counting Indian country risk, once in the government bond rate and once again in the equity risk premium.

    I know that the ERP is in dollar terms, and adding it to a rupee riskfree rate may seem inconsistent, but it will work well for riskfree rates that are reasonably close to the US dollar risk free rate. For currencies, like the Brazilian real or Turkish lira, it is more prudent to do your calculations entirely in US dollars, and convert using the differential inflation rate:

US dollar riskfree rate on July 1, 2025 = 3.97%

ERP for Turkey on July 1, 2025 = 10.87%

Expected return on average Turkish equity in US $ on July 1, 2025 = 3.97% + 10.87% = 14.84%

Expected inflation rate in US dollars = 2.5%; Expected inflation rate in Turkish lira = 20%

Expected return on average Turkish equity Turkish lira on July 1, 2025 = 1.1484 *(1.20/1.025) -1 = 34.45%

Note that this process scales up the equity risk premium to a higher number for high-inflation currencies.

Step 3: Estimate the equity risk premium or premiums that come into play based on operations

   Many analysts use the equity risk premiums for a country when valuing companies that are incorporated in that country, but I think that is too narrow a perspective. In my view, the exposure to country risk comes from where a company operates, not where it is incorporated, opening the door for bringing in country risk from emerging markets into the cost of equity for multinationals that may be incorporated in mature markets. I use revenue weights, based on geography, for most companies, but I am open to using production weights, for natural resource companies, and even a mix of the two. 

In corporate finance, where you need equity risk premiums to estimate costs of equity and capital in project assessment, the location of the project will determine which country’s equity risk premiums come into play. When Amazon decides to invest in a Brazilian online retail project, it is the equity risk premium for Brazil that should be incorporated, with the choice of currency for analysis determining the riskfree rate. 

Step 4: Estimate project-specific or company-specific risk measures and costs

    The riskfree rate and equity-risk premiums are market-wide numbers, driven by macro forces. To complete this process, you need two company-specific numbers:

• Not all companies or projects are average risk, for equity investors in them, and for companies that are riskier or safer than average, you need a measure of this relative risk. At the risk of provoking those who may be triggered by portfolio theory or the CAPM, the beta is one such measure, but as I have argued elsewhere, I am completely at home with alternative measures of relative equity risk. The cost of equity is calculated as follows: 

Cost of equity = Riskfree rate + Beta × Equity Risk Premium

The beta (relative risk measure) measures the risk of the business that the company/project is in, and for a diversified investor, captures only risk that cannot be diversified away. While we are often taught to use regressions against market indices to get these betas, using industry-average or bottom-up betas yields much better estimates for projects and companies.

• For the cost of debt, you need to estimate the default spread that the company will face. If the company has a bond rating, you can use this rating to estimate the default spread, and if it is not, you can use the company's financials to assess a synthetic rating.

Cost of debt =Riskfree Rate + Default spread

Harking back to the discussion of riskfree rates, a company in a country with sovereign default risk will often bear a double burden, carrying default spreads for both itself and the country.

The currency choice made in step two will hold, with the riskfree rate in both the cost of equity and debt being the long-term default free rate in that currency (and not always the government bond rate).

Step 5: Ensure that your cash flows are currency consistent 

    The currency choice made in step 2 determines not only the discount rates that you will be using but also the expected cash flows, with expected inflation driving both inputs. Thus, if you analyze a Turkish project in lira, where the expected inflation rate is 20%, you should expect to see costs of equity and capital that exceed 25%, but you should also see growth rates in the cash flows to be inflated the same expected inflation. If you assess the same project in Euros, where the expected inflation is 2%, you should expect to see much lower discount rates, high county risk notwithstanding, but the expected growth in cash flows will also be muted, because of the low inflation.

    There is nothing in this process that is original or path-breaking, but it does yield a systematic and consistent process for estimating discount rates, the D in DCF. It works for me, because I am a pragmatist, with a valuation mission to complete, but you should feel free to adapt and modify it to meet your concerns. 

YouTube Video

Paper

1. Country Risk Determinants: Determinants, Measures and Implications - The 2025 Edition

Datasets

1. Equity Risk Premiums, by country - July 2025

Country Risk Links

1. EIU Democracy Index
2. Global Peace Index (Exposure to Violence)
3. Corruption Index
4. International Property Rights Index
5. Moody's Sovereign Ratings
6. Political Risk Services (PRS) Country Risk Scores

Spreadsheets

1. Implied Equity Risk Premium for S&P 500 on July 1, 2025