The country risk premium is the return that investors demand from a country to buy its sovereign bonds in comparison with that demanded from other countries. It is calculated as the difference between the interest rate of a country’s bonds compared to bonds issued by a benchmark country, considered “riskless.”
The country risk premium is a measure of the ‘extra cost’ that a country has to pay compared to another one to finance itself in the markets. Normally, this spread measures the risk that investors take when buying public debt in a given country. The higher the risk, the higher the cost of financing (interest rate) and vice versa.
It is calculated as the difference between the interest rate paid by a country’s public debt and the interest paid by the debt issued by another “without risk” with the same maturity (normally ten years).
In the euro area, the German bond is used as the benchmark, as it is considered the safest. In fact, the credit rating assigned by the main agencies to Germany is AAA, which implies that the chances of default on the German debt is virtually zero.