Should Managers Estimate Cost of Equity Using a Two-Factor International CAPM?

Abstract

For a large sample of U.S. companies, we compare the cost of equity estimates of a two-factor international CAPM with those of the single-factor domestic CAPM and the single-factor global CAPM. Our purpose is to assess how much difference it makes for U.S. firms to use the two-factor ICAPM instead of a single-factor model. We find: 1) the cost of equity estimates of the two-factor ICAPM are reasonably close to those of either single-factor model for U.S. firms with low-to-moderate foreign exchange exposure; and 2) perhaps surprisingly, for U.S. firms with extreme foreign exchange exposure, the cost of equity estimates of the two-factor ICAPM tend to be very close to those of the domestic CAPM, and even closer than to those of the single-factor global CAPM.

Keywords: International CAPM, Global CAPM, Domestic CAPM, Cost of Equity, Currency Exposure

JEL Classification: F3, G1, G3