Global Risk Factors and the Cost of Capital

In the past two decades, analysts have observed increasing integration of international financial markets. Barriers to international investment among developed economies have slowly but steadily diminished. Hence, global risk factors are increasingly important for portfolio selection and asset pricing. Recent empirical evidence indicates, specifically, that global factors - notably, exchange rates - affect the pricing of stocks in industrialized countries. These developments suggest that an international capital asset pricing model (ICAPM) should be used for computing a company's cost of equity capital. Practitioners, however, predominantly use the single-factor domestic CAPM for estimating the cost of capital. We examine to what extent global factors make a difference in practical cost-of-capital computations...