by Patrick Diethelm
In a very interesting note posted on 28 January 2024 on LinkedIn, Professor Aswath Damodaran described various risk measures of the equity market. In this article he mentioned that there were perceived risk differences across companies, sectors and countries, the latter being described as macro risks. These macro risks were grouped in four categories, and I quote:
Political structure, which can cause public policy volatility
Corruption, which operates as an unofficial tax on income
War & violence, which create physical risks that have economic consequences
Legal & property rights, which offer protections without which businesses quickly lose value
He also presented an array featuring most countries in the world and their equity perceived risk premium. In this list, one can notice that North American and Western European countries have the lowest equity risk premium. I guess that a democracy is considered more stable, the corruption in these countries is also low, this region has been relatively peaceful, and these countries have strong legal and property rights. All these factors comfort investors when assessing the risk of their investment in this region.
What makes these developed countries special is that they are law abiding countries, which make it easy to do business. If you know the rules, and you follow the rules, your business activity is relatively straight forward.
What troubles me is the aftermath of the recent ruling by the International Court of Justice. In January, this court had a difficult case brought up by South Africa against Israel and came with a ruling, which went in favour of South Africa and against Israel. What surprised me is that many of these countries announced that they will not follow this court decision. What is surprising is that these countries set up the United Nations at the end of Second World War, and the creation of the ICJ was part of that process.
Does this mean that things have changed? Going forward, if a decision doesn’t suit them they simply decide not to follow the court order? If this is the case, we might have to reconsider the risk premium we use in evaluating our investments as they could decide to not abide by court orders of their own judicial system.
Many of these countries are clamouring that they are rules based countries, I can understand what is a law abiding country, but what are these rules? Where can we find them written?
I would prefer them clamouring that all their decisions follow their laws, and the international law. At least we know where to read and study them, and most of the time they can only be changed in well established, and transparent process. Till then, one should maybe consider increasing the risk premium to ones investments in order to offer some more buffer.
Stay tuned,
Patrick Diethelm