International investment risk analysis: extensions for multinational corporation capital budgeting models

Abstract

Multinational corporation managers often rely upon net present value modelsusing differing foreign discount rates that contain implicit ϱ jk ( t ) relative risk premiums equal to the difference between Country j and Country k discount rates at Time t . Recent surveys shows that these risk premiums are usually subjective and rarely justified in an analytical context. The major purpose of this paper is to propose a means whereby ϱ jk ( t ) relative risk premiums may be derived from investor judgements regarding r jk ( t ) perceived multiple country foreign investment risk differentials. The r jk ( t ) responses are based upon the amount of a Country j return that would be required in Year t for the respondent to be indifferent per dollar of return from Country k having different types and levels of investment risk. This paper proposes means whereby the r jk ( t ) risk differential equivalencies may be elicited as dynamic time functions and aggregated as geometric means for multiple respondents. Inconsistent r jk ( t ) responses may be adjusted for consistency either by eigenvector scalings or least-squares scalings. This paper illustrates an optimal least-squares scaling procedure. The analysis proposed in this paper facilities multiple-criterion analysis via Analytic Hierarchy Process (AHP) analysis. An AHP formulation is illustrated in the paper.