Should managers estimate cost of equity using a two‐factor international CAPM?

Abstract

Purpose

The purpose of this paper is to assess how much difference it makes for US firms to use the two‐factor ICAPM to estimate their cost of equity instead of a single‐factor CAPM.

Design/methodology/approach

For a large sample of US companies, the authors compare the empirical cost of equity estimates of a two‐factor international CAPM with those of the single‐factor domestic CAPM and the single‐factor global CAPM.

Findings

The authors find that the cost of equity estimates of the two‐factor ICAPM are reasonably close to those of either single‐factor model for US firms with low‐to‐moderate foreign exchange exposure; and second, perhaps surprisingly, for US firms with extreme foreign exchange exposure, that 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.

Research limitations/implications

The paper's findings might prove useful to academic researchers wanting to resolve the seemingly contradictory empirical results on the pricing of FX risk.

Practical implications

The findings will hopefully help managers decide whether they should go to the trouble of estimating a US firm's cost of equity with the two‐factor international CAPM instead of a traditional single‐factor CAPM.

Originality/value

The paper extends the existing literature by focusing on the two‐factor ICAPM, and finds some new and surprising empirical results.

Citation

Dolde, W., Giaccotto, C., Mishra, D.R. and O'Brien, T. (2012), "Should managers estimate cost of equity using a two‐factor international CAPM?", Managerial Finance, Vol. 38 No. 8, pp. 708-728. https://doi.org/10.1108/03074351211239360