International Capital Asset Pricing Model Research Articles

A state-dependent international CAPM for partially integrated markets: Using local and US risk factors

This study investigates the impact of emerging economies' trade levels with the US and exchange rate systems on their interdependency with the US market. We employ a comprehensive approach, analyzing both local factors (such as illiquidity and dividend yield) and US risk factors (including the S&P500 Index, US effective exchange rate, and term spread) to discern various market phases and capture equity returns. Utilizing a State-dependent International CAPM framework, we reveal a common trend among market returns: the reduced informativeness of both US and local variables during transitions from low to high volatility states. Notably, the majority of emerging markets respond to signals from the US equity market during bullish periods. We also highlight the critical role of exchange rate regimes in explaining the sensitivity of emerging markets to US risk factors. While the illiquidity ratio emerges as a significant local risk factor, its informativeness wanes during bear markets. These findings offer valuable insights for asset allocation, diversification, and risk management strategies tailored to the dynamic nature of emerging markets.

Re-estimation of the savings retention coefficient in OECD countries: a new measure of home country bias

The recent home bias is primarily related to the equity bias as measured by the international capital asset pricing model (CAPM); this measure has declined over the past two decades amid financial globalization, but remains high in most developed countries. The key to understanding this puzzling phenomenon lies in how accurately this indicator can be predicted. In this paper, we propose to use the savings retention coefficient estimated by the Feldstein–Horioka (F–H) regression as a cross-country measure of home bias. We re-estimate the savings retention coefficient based on an estimation model in which the FH regression is embedded in the model derived from Tobin's q-theory of saddle-road dynamics of investment under convex adjustment costs. We then use dynamic panel estimation to estimate the new measure in OECD countries. The main empirical results are as follows. The new measure of home country bias, such as the equity bias measure, declined steadily until 2008, but recovered to the level of the 60 s and 70 s after the 2008 financial crisis. Interestingly, people expected home country bias to be very high after the financial crisis, but in fact it simply returned to its previous level.

Oil Price and Composite Risk Exposure within International Capital Asset Pricing Model: A Case of Saudi Arabia and Turkey

The aim of this study was to investigate and compare investment opportunities in the financial markets of Saudi Arabia, a net oil-exporting country, and Turkey, a net oil-importing country, in the Middle East. The international capital asset pricing model (ICAPM) was extended by considering local factors proxied by country risk (CR) and oil price risk exposures of the excess returns of Saudi Arabia and Turkey. In this study, we employed the extended ICAPM in a two-state Markov-switching setting for the sample period of January 2005 to December 2018 to explore whether the risk premium is time-varying. The results suggested that systematic risk is time-varying depending on the state of the financial markets and is affected by both global and local factors. Saudi Arabia offered higher excess returns during the high-volatility regime compared to that of the World Index and enjoyed higher returns during the low-risk regime from oil price shocks. Turkey was negatively affected by oil price shocks and was rather sensitive to the country’s risk factor, which varied with both the state of the market and the time factor. These findings will be useful to international investors in diversifying their risks. This study differs from others in estimating the risk premium (beta) by taking into account both the local and global factors and the dynamic nature of systematic risk.

How does exchange rate elasticity of aggregate consumption adjust currency risk price in the stock market?

Based on a simple two-good, two-country CCAPM framework, in which aggregate consumption growth is connected to exchange rate fluctuations by the exchange rate elasticity of aggregate consumption (EREAC), we extend a parsimonious international CAPM model to detect the role of EREAC in the change in currency risk price and illustrate that EREAC moves explain the time-varying nature of currency risk price. In our model, currency risk price is expressed as a function of both EREAC and its related threshold value. Thus, under the condition of the identified correlation directionality between stock returns and exchange rate fluctuation, we claim that EREAC influences the currency risk price, where the two types of EREAC states (above or below its threshold value) have inverse effects on the currency risk price direction. Through an empirical test, we find evidence that EREAC can sagaciously adjust the currency risk price as we propose. Our main result implies that EREAC can be as a potential state variable in currency risk prices, and from the perspective of EREAC moves, we can give a partially plausible interpretation of the cause of the time-varying nature of currency risk prices to some extent.

INTEGRATION OF SOUTHEAST ASIAN STOCK MARKETS WITH THE WORLD STOCK MARKET: APPLICATION OF INTERNATIONAL ASSET PRICING MODEL

This study aims to determine the integration level of Southeast Asian stock market with the world stock market using an international capital asset pricing model. The countries that were sampled in this study were Indonesia, Malaysia, Philippines, Singapore and Thailand. The sample period starts from January 2000 until August 2016. This study uses an partially-segmented international capital asset pricing model by including the assumption of residual that were correlated between asset pricing equations. Because of this assumption, the seemingly unrelated regression (SUR) estimation method is more appropriately compared to the ordinary least square (OLS) method. The results of this study indicate that the integration level of Southeast Asian stock market varies. The Singapore and Thailand stock markets are fully integrated with the world stock market, the Indonesian and Malaysian stock markets are partially integrated with the world stock market, while the Philippine stock market is segmented with the world stock market. This finding shows the difference in the effectiveness of the stock market liberalization process in Southeast Asia

Cross-border valuation using the International CAPM and the constant perpetual growth model

For cross-border valuation to be consistent with the International CAPM (ICAPM), translating projected cash flows across currencies should account for a currency risk premium and the economic interaction between uncertain cash flows and uncertain exchange rates. The conventional translation method ignores these items. This study proposes a translation method that is consistent with the ICAPM, given the constant perpetual growth model of valuation. Using empirical data, the study illustrates the conventional translation method’s potentially substantial valuation error if the ICAPM describes the risk-return trade-off in financial markets.

The Foreign Exchange Risk Premium in the Cross-Section of Stock Returns: International Evidence

Using the framework of the International Capital Asset Pricing Model, we estimate unconditional FX risk premiums for a large cross-section of firms from local currency perspectives. Further, we study the impact of potential FX risk diversifiability on FX risk premiums. Using equity data from nine major financial markets, we find support for FX risk being a contributing factor to stock return volatility in eight and a priced factor in four of the sample markets. Empirical estimates of FX risk premiums are economically meaningful, negative for U.S. and Swiss firms, and positive for Australian and Canadian firms.

Equity-commodity contagion during four recent crises: Evidence from the USA, Europe and the BRICS

This study extends the findings of previous research concerning the correlation and volatility transmission between equity and commodity markets and attempts to document evidence of contagion between these markets during four crises using the International Capital Asset Pricing Model (ICAPM). Indeed, we examine the contagion transmission mechanism between regional equity markets including the USA, Western Europe and the BRICS; and sixteen categories of commodities (Crude Oil, Natural Gas, Electricity, Metals, Precious Metals, Agricultural Oils, Chemicals, Feeds, Fibers, Forestry Products, Grains, Live Stocks, Oil Seeds, Seeds, Semi-Conductors, and Softs). We find that although most of the commodities decoupled during the global financial crisis, the Irish banking crisis and the European debt crisis, there is strong evidence of contagion detected during the BREXIT.

Global financial integration and monetary policy spillovers

Using de facto financial market integration estimated based on an international CAPM, this paper finds that while emerging markets can keep monetary autonomy under the trilemma constraint, advanced economies have limited autonomy due to tight financial integration in recent decades.

Can Cross-Border Funding Frictions Explain Financial Integration Reversals?

Abstract We show that constraints on using leverage for foreign positions can act as an international investment barrier. Guided by an international CAPM with leverage constraints, we use observed stock prices to measure the variation in the magnitude and the implicit cost of such cross-border funding barriers. Our measure helps explain the dynamics of global market integration and, in particular, its reversals documented in the literature, but not explained by other international investment barriers. We confirm our results using alternative financial integration measures, international capital flows, and institutional portfolio holdings.

БАГАТОФАКТОРНІ МОДЕЛІ ОЦІНЮВАННЯ ІНВЕСТИЦІЙНИХ ПРЕМІЙ: АНАЛІЗ ДИСКУРСУ ТА МІСЦЕ В СУЧАСНІЙ ТЕОРІЇ МІЖНАРОДНОГО ПОРТФЕЛЬНОГО ІНВЕСТУВАННЯ

The paper dwells on multi-factor models of individual securities and investment portfolios expected returns and investment premiums valuation. Main stages of these models appearance and development are discovered. Theory and practice realized that single-index models were not relevant in terms of estimating expected returns, since at least several basic factors affected premiums substantially. Notwithstanding the basic principle of compensating risk beared by respective return remained unchanged two new models – intertemporal CAPM and international CAPM were underlying dynamic development of multi-factor models. The latter along with market risk factor considered other premium components like those resulting from exchange rate risks for different currencies. Components of scientific discourse in this field are identified, position of models under question in contemporary theory of international portfolio investing is defined. Multi-factor models expanded and enhanced portfolio paradigm of international investing, particularly its specific concept of expected returns valuation. Unlike some other paradigm components this concept is proved to be positive theoretically and well applicable in practice. Factors of international models of investment premiums valuation origin are specified. More precise emphasize is made on international multi-factor CAPM and APT models. More cross functional nature of arbitrage pricing model compared to CAPM is justified. Gnoseological status of Fama and French multi-factor model is specified. Its affiliation with both existing paradigms of international investing – value investing and portfolio paradigm is argued. This in turn determines its unique position in existing knowledge in the field. Technically and methodologically it was developed on the ground of traditional CAPM model – it implies existing risk factor, specific sensitivity ratio to the existing risk factor and respective investment premium. This justifies the model affiliation with traditional and dominating portfolio paradigm of international investing. On the other hand, in its current version the model completely corresponds with value paradigm principles. Intrinsic, internal value of securities is defined, the valuation is subjective, traditional fundamental analysis ratios like book-to-market value index are used. The model thus establishes particular connection between two paradigms of international portfolio investing.

ЛОКАЛЬНІ ТА МІЖНАРОДНІ ЧИННИКИ ФОРМУВАННЯ ДОХІДНОСТЕЙНА ФІНАНСОВИХ РИНКАХ:ЕВОЛЮЦІЯ МОДЕЛЕЙ ОЦІНЮВАННЯ ІНВЕСТИЦІЙНИХ ПРЕМІЙ

The paper suggests retrospective analysis of investment premiums valuation models. Their place in contemporary theory of international portfolio investing is defined. Main phases of these models' evolution are revealed, uppermost considering incorporation of local and international factors of expected returns. Basic features of these phases are discovered. Dominance of the CAPM model in the framework of expected returns valuation concept is validated. This model is underlying major part of the science in this field development, particularly zero beta model and intertemporal model. Gnoseological conditions of models including international factors of securities premiums origin and development are identified. Specific attention is paid to models considering currency risk factor – one of the key factors of expected returns in international investment environment. Major events of the world economy that actualized the necessity of considering currency risks while valuing investment premiums are singled out. International capital asset pricing model as one that incorporates currency risk factor during expected returns valuation in the best way is examined. Comparative analysis of international CAPM and the approach of using the traditional model in international market is carried out. Although no evident advantage of any is fixed, existing empirics proves that the latter is much more convenient in terms of its usage, and is actually used much more often. The rationale of methodological priority of using the term "premium" rather than "expected return" is presented. Methodological indifference between the terms "price" and "expected return" in the current context is reported.

Equity-Commodity Contagion During Four Recent Crises: Evidence from the USA, Europe and the BRICS

This study considers the findings of previous research concerning the volatility and correlation transmission between equity and commodity markets and at- tempts to document evidence of contagion between these markets during four crises using the International Capital Asset Pricing Model (ICAPM). We study existence of contagion transmission mechanism between regional equity markets (USA, Western Europe and the BRICS) and sixteen categories of commodities (Crude Oil, Natural Gas, Electricity, Metals, Precious Metals, Agricultural Oils, Chemicals, Feeds, Fibers, Forestry Products, Grains, Live Stocks, Oil Seeds, Seeds, Semi-Conductors, and Softs). We find that while most of the commodities decoupled from the Global financial crisis, the Irish Banking crisis and the European debt crisis, evidence of contagion were detected during the BREXIT.

The Empirical Study of International Risk Factor on the Korean Stock Market: Cross-Sectional Analysis through Intertemporal and International Capital Asset Pricing Model

본 연구는 기간 준거 자본자산 가격결정모형(Intertemporal capital asset pricing model)과 국제 준거 자본자산 가격결정모형(International capital asset pricing model)을 근거로 한국 주식시장의 국제 위험요인(risk factor)을 도출하였다. 국내 금융시장은 물론 다른 국가들의 금융시장들의 대외개방도가 높아지면서 금융시장간 연계성이 매우 밀접해졌다. 하지만 한국 주식시장에 대한 실증연구에서는 아직 국내 금융시장으로부터 도출된 위험요인만을 고려하고 있는 상황이다. 본 연구는 기간 준거 자본자산 가격결정모형과 국제 준거 자본자산 가격결정모형을 통해 한국 주식시장에서 국제 위험요인이 위험프리미엄을 생성하는지 실증분석 하였다. 기간 준거 자본자산 가격결정모형과 국제 준거 자본자산 가격결정모형에 따르면 이론적으로 국제 전체 및 다른 국가의 종합주가지수에 대한 수익률과 변동성을 통해 한국 주식시장의 횡단면을 설명하는 위험요인을 도출할 수 있다. 실증분석 결과, 수익률의 경우에는 국제 전체, 북아메리카, 아시아, 미국 및 독일 시장이 한국 주식시장의 위험요인으로 작용하였다. 변동성의 경우에는 북아메리카, 미국, 중국 및 독일 시장이 위험요인으로 작용하였다. 이처럼 한국주식시장은 해외 위험요인에 의해 설명될 수 있음을 알 수 있다. 또한 해외의 변동성을 통해 도출된 위험요인은 한국 고유의 위험요인인 기업규모 요인(SMB)를 대용하고 있는 것으로 나타났다.This study uncovers the international risk factor for the cross-section of stock returns in Korea through the Intertemproal and International capital asset pricing model. The degree of financial openness of the Korean financial market and international financial markets have been growing so that interconnectedness of financial markets are also increased. The research, however, related to the cross-section of stock returns in Korea has not discussed the international risk factors, but local risk factors. This study sheds light on the priceness of international risk factors through the intertemporal and international capital asset pricing model. These two models theoretically command that stock market return and its variance of global financial market and each foreign country can be the good sufficient statistics for the domestic investment opportunity set. The empirical results show that the stock market returns of Global, North America, Asia, USA, Germany are the sufficient statistics for the investment opportunity set domestic investors care. In the case of stock market variance, the variances of North America, USA, China and Germany are the sufficient statistics for the investment opportunity set investors are concerned about for hedging their marginal utility. For the further study, size factor, one of the pricing risk factor in the Korean stock market, can be subsumed by the risk factor from the intertemporal and international capital asset pricing model.

Freedom of the Press and Equity Returns: Empirical Investigation in Emerging Markets

This article studies the relationship between freedom of press and equity returns in emerging markets. While research has shown that asymmetric information is one reason for high volatility and one type of risk in financial markets, the role of press in reducing that risk has not yet been studied thoroughly. The article attempts to bridge that gap and investigates how a free and unbiased press affects excess returns in stock market. Using the International Capital Asset Pricing Model (ICAPM), Fama-MacBeth’s methodology, and dataset from16 emerging economies from 1986 to 2000, this research is able to show that cross-country excess returns are significantly related to the degree of press freedom.

International Capital Budgeting and Valuation: Review and Proposed Approach

For cross-border valuation to be consistent with the International CAPM (ICAPM), translating projected cash flows across currencies should account for a currency risk premium and the economic interaction between the cash flows and exchange rates. The conventional translation method, based on the traditional interest rate parity condition, ignores these items and is thus not consistent with the ICAPM. Using the constant perpetual growth model and empirical data from 12/31/1998 to 6/30/2020, this study illustrates the conventional translation method’s potentially substantial valuation error if risk and expected return are based on the ICAPM.

The impact of exchange rates on stock market returns: new evidence from seven free-floating currencies

ABSTRACTThis paper provides evidence of a significant exchange rate effect on stock index returns using data from seven selected countries practicing free-floating exchange rate regimes. This research uses parity and asset pricing theories, thus placing it within the monetary-cum-economics framework for international asset pricing. In this study, we apply a system of seemingly unrelated regression to control for unobserved heterogeneity and cross-sectional dependence. The findings constitute evidence of a statistically significant exchange rate impact on stock index returns across selected countries. These findings can be considered as falling under the arbitrage pricing approach of the international capital asset pricing model of Solnik who also used the parity-theoretical framework on exchange rate determination.

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

The cited reference Nguyen et al. (2017) should have been set as Al Janabi et al. (2017) in the first paragraph of introduction.

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

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.

Commodities risk premia and regional integration in gas-exporting countries

This study examines the fundamental driving forces of stock market integration with particular emphasis on major Gas-Exporting Countries (hereafter known as GECs), namely the United Arab Emirates, Qatar, Venezuela, Saudi Arabia, Russia, and Kuwait, over the period from June 2003 to November 2017. The novelty of our study stems from the fact that we examine a dynamic process of international, regional and national stock markets integration using a set of local, regional, global and commodities as driving forces of integration. Particularly, we measure market integration using gas price as a common source of risk in addition to the world, regional and domestic sources of risk based on a conditional version of the International Capital Asset Pricing Model (ICAPM). Our study also differs from past ones in that we investigate the integration of stock markets into the international market as well as in the GECs countries. Our results show that the level of market integration of the major gas-exporting countries varies widely over time and depends on the interest rate spread, the level of market openness and market volatility. It also seems to be still significantly segmented from both the global and GECs markets. Gas risk represents a small part of the global risk in all the countries considered in this study.