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Country Risk and International Portfolio Diversification

Erol Balkan and Umit Erol
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Umit Erol: Bilkent University. Ankara, Postal: Eskisehir Yolu 8. Km, Ankara, 06800, Turkey, http://bilkent.edu.tr/

Economia Internazionale / International Economics, 1995, vol. 48, issue 1, 1-12

Abstract: The purpose of the paper is to find out if the pricing of international loans can be explained by the Capital Asset Pricing Model. An empirical test that includes a set of 33 developing countries during the period 1971-1984 is undertaken. The data also permits a calculation of expected returns using a non-linear probit model to identify the probabilities of default. The results suggest that a certain degree of diversification holds, while non-diversifiable systematic risk contributes to the explanation of market risk premiums. However, the CAPM model cannot fully account for the variation in the observed risk premia. Other factors may also contribute to the pricing of loans. In particular, the absence of secondary markets during the estimation period may explain the divergence of actual behavior from that implied by the CAPM framework.

Date: 1995
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