International companies may be attracted to the promise of fast-growing emerging markets, but they are unnecessarily cautious when assessing potential investments there. Certainly, some caution is understandable. High-profile setbacks in Russia, difficulties in managing operations in China, and the on-again, off-again performance of Latin America have heightened sensitivities to the risks of investing in the developing world.

Unfortunately, the perception of elevated risk leads companies to reject good investment opportunities and to underestimate the performance of existing businesses. What should be a clinical evaluation of a company’s many investment decisions gets distorted, affecting even the analyses used to evaluate a project’s risk-and-return profile. As a result, analysts and business managers overestimate the risk premium, assigning it to levels that even substantial underlying risks would not justify. Thus they also grossly inflate assumptions about the cost of capital—often pegging it at more than twice the level of similar projects in developed economies.

We took a close look at the risk of doing business in emerging markets and found that when it is spread over a diverse portfolio of investments, it is really much more modest. While risk in any individual emerging market may be higher than it is in developed...