Do Global Risk Factors Matter for International Cost of Capital Computations?

Abstract:     
International financial markets are becoming integrated. Hence, globalrisk factor are increasingly important for portfolio selection andasset pricing. The recent empirical finance literature has confirmedthat both the global market portfolio and exchange rate risk factorsconstitute important determinants of asset returns. We show, however,that global risk factors do not importantly affect estimates of thecost of equity capital for a remarkably wide variety of companies. Weanalyze almost 3,300 stocks from nine industrialized countries overthe period 1980-1999. Incorporating global factors into cost ofcapital estimations leads to an adjustment of roughly 50 basis pointsper annum on average for the U.S. and 70 to 100 basis points for theother countries. Adjustments of this magnitude easily fall inside themargin of error associated with actual cost of capital computations.Specifically for U.S. companies, the amendment of the cost of capitalestimate is generally very small. This suggests that global riskfactors do not really matter for computing the cost of capital of U.S.firms.

Keywords: cost of equity capital, exchange rate risk, capital budgeting, valuation

JEL Classifications: M, M41, G3, G15, G31, F31

Working Paper Series