International capital asset pricing model: the case of asymmetric information and short-sale

Abstract

We develop an international capital asset pricing model in the presence of shadow costs of incomplete information and short sales. Our model shows the direct effect of exchange rate risk, information costs and short sales costs on asset prices. At equilibrium, this model gives an explicit expression of two systematic risk premium. The first one is linked to the exchange rate. The second one is related to international market risk. Our model explains in part the well-known home bias equity by market segmentation. This model, which is proposed for the first time in the literature, can be seen as an international version of Wu et al. (Rev Quant Finance Account 7:119–136, 1996) and Merton (J Finance 42:483–511, 1987) models of capital market equilibrium in international markets. Our analysis shows that the dispersion in beliefs increases the market inefficiency, and that short sale constraints can reduce the cost of ignorance and the magnitude of the home bias equity. Our model provides an operational approach in asset pricing to take account of previous important costs.