The average (2ER (or VAREX = variance of export revenue) of a group of countries has been estimated at 20 percent. The individual VAREXes of two countries in the group, the Netherlands and Singapore, have been estimated at 15 percent and 28 percent, respectively. The regression of individual country VAREX on average VAREX provides the following beta (coefficient) estimates:
(H = Beta of the Netherlands = 0.80
(S = Beta of Singapore = 0.20.
a. Based only on the VAREX estimates, which country should be charged a higher risk premium? Explain.
b. If FIs include systematic risk in their estimation of risk premiums, how would your conclusions to part (a) be affected? Explain.