Cost of Equity Capital and Country Risk: An econometric analysis of the expected rate of return for four Latin American countries

Expected returns and risk assessment are important issues when evaluating capital investment projects. We use VARX-MGARCH models and asset pricing theory to model the expected rate of return in Brazil, Colombia, Mexico and Peru for late 2006. The main objective of this paper is to present an econometric study of the cost of equity1 capital based upon Erb, Campbell, Harvey, and Viskanta (1996) modelling in emerging markets through country risk. We use MSCI’s DTR for measuring market performance and J.P. Morgan’s EMBI+spread to proxy country risk and then construct conditional mean and variance models in a univariate and multivariate context.