Do Global Risk Factors Matter for International Cost of Capital Computations?
International financial markets are becoming integrated. Hence, global risk factor are increasingly important for portfolio selection and asset pricing. The recent empirical finance literature has confirmed that both the global market portfolio and exchange rate risk factors constitute important determinants of asset returns. We show, however, that global risk factors do not importantly affect estimates of the cost of equity capital for a remarkably wide variety of companies. We analyze almost 3,300 stocks from nine industrialized countries over the period 1980-1999. Incorporating global factors into cost of capital estimations leads to an adjustment of roughly 50 basis points per annum on average for the U.S. and 70 to 100 basis points for the other countries. Adjustments of this magnitude easily fall inside the margin of error associated with actual cost of capital computations. Specifically for U.S. companies, the amendment of the cost of capital estimate is generally very small. This suggests that global risk factors do not really matter for computing the cost of capital of U.S. firms.
|Keywords||capital budgeting, cost of equity capital, exchange rate risk, valuation|
|Publisher||Erasmus Research Institute of Management (ERIM)|
Koedijk, C.G., & van Dijk, M.A.. (2002). Do Global Risk Factors Matter for International Cost of Capital Computations? (No. ERS-2002-100-F&A). Erasmus Research Institute of Management (ERIM). Retrieved from http://hdl.handle.net/1765/249