Risk premiums on Tel Aviv-25 index stocks fell to about 3.5 percent from 6% between 1997 and 2005 "and in particular in the last two years," according to a study released Thursday by the Bank of Israel.
The downward trend in risk premiums is characteristic of other markets throughout the world too, the researchers noted.
"Globalization has certainly contributed" to the lower premiums by opening up markets and facilitating investment in emerging markets, GIFT Asset Management currency analyst Eran Basson explained. Investors, he suggested, are willing to receive lower risk premiums due to their desire to vary their portfolios and their confidence in the economy of the country in question, whether India, China or Israel.
One example of the trend is in the shrinking cushion between the US and shekel interest rates, which has been reduced from at least 1.5 percentage points in past years to "only" about one-quarter point currently, Basson said. "Yet the shekel is still gaining strength and there is still inflow of foreign investment," he noted, despite the lower compensation for the risk of investing in Israel.
In comparison, some interest rates in Latin America hover around 15% - granting about a 10-percentage point cushion above the current US level - "and that certainly attracts investors' attention," Basson said, particularly when the US interest rate hit 1%, or among investors from Japan, where the interest rate is 0%.
Nonetheless, the increased freedom is a two-way street, Basson warned, and the damage likely to be caused by a massive flight of foreign investors from an emerging market could well be greater than if the money had never come in, he suggested.
"In my opinion, the risks are actually greater, not lesser," he said.
Risk premium on the NIS/US$ exchange rate, as well, fell from about 2% to 1% between 1997 and 2005, the researchers noted.
The risk premium is the excess return required by investors on their investment in a financial asset. The higher the perceived risk of an asset, the higher the return required to compensate for the risk.
In the study, researchers Elena Pompushko of the central bank's monetary department and Yoel Hecht of the Bank Supervisor Yoav Lehman's office presented a new method for measuring the risk premium on assets traded in the capital market, which allows the premium to be calculated on a continuous basis in the course of trading on the stock exchange.
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