The influence of the degree of the Russian stock market integration on the cost of equity

Abstract

Subject. This paper examines how to determine the cost of equity for a developing economy, if the latter is segmented from the leading developed economy of the world. Objectives. The aim is to establish the importance of determining the cost of equity in the Russian economy, depending on the country of the developed market. Methods. All well-known international methods for determining the cost of equity, taking into account the country risk, are involved in the analysis. For calculations, I use yields of the world’s important market indices. Results. The study shows that the value of equity capital (subject to country risk), which is established under all international methods for the reference market of European developed countries, will be lower. Conclusions. CAPM models, used for developed markets, produce too low cost of capital, when they are applied as-is to developing countries. Therefore, for developing countries, models are used, which rest on the idea of adding a country risk premium to the risk premium, for the reference market of a developed country. This theory does not regulate the choice of a reference market from among developed countries. However, some studies found that the US market is not the most influential for the Russian market. The paper states that the choice of European developed countries provides a 16.8% reduction in the cost of equity, which, in turn, provides an increase in company value by a third.