Country risk premia and a second Trump administration

Discontinuous versus continuous risk

We have previously noted that a second Trump administration might be good for USD denominated asset markets, at least on a relative basis. An increase in economic policy and geopolitical uncertainty could be expected to benefit the US dollar, in part because of negative international spillovers from US policy. A reduction in the US corporate tax rate to 15% would, at least in isolation, be good for US stocks and attract foreign capital inflows, but could also be broadly offset by trade frictions that fragment global supply chains and reduce cross-border investment.

As Ernie Tedeschi notes in a recent paper (Political Risks to the U.S. Safe Harbor Premium), country risk is a relative concept and since the US normally serves as the risk-free benchmark, it is often awarded a country risk premium of zero by default. Aswath Damodaran’s widely referenced country risk premia estimates assign a zero country risk premium to the US, Canada, Switzerland, Germany and Australia. But this does not mean that these countries are risk-less in an absolute sense, even if they are considered low risk in a relative sense.

Tedeschi estimates a shadow country risk premium for the US relative to the shadow CRP’s of other countries normally assigned a zero CRP (including Australia). His results suggest that the US has a shadow CRP of 25-35 basis points relative to these riskless benchmarks. The US shadow risk premium was falling against these benchmarks from 2006-2016, troughed in 2016, and has risen 20-25 basis points since then, with most of the rise occurring during 2020. Tedeschi never mentions Donald Trump, but the narrative identification pretty much writes itself.

Source: Tedeschi (2024).