International Capital Asset Pricing Model Research Articles

A Political Capital Asset Pricing Model

We construct a bivariate factor of political stability and economic policy confidence and show that it commands a significant premium of up to 15% per annum, in the global, developed, and emerging markets, robust to ICAPM, Fama-French five-factor model, Carhart, and ICAPM Redux. We propose an international capital asset pricing model incorporating the political factor, and test global and local estimations in developed and emerging economies. The model explains up to 77% of cross-sectional returns, has good predictive power, in several tests it performs better than the benchmark models in pricing equity indices and explains up to an incremental 25% of cross-sectional returns and is robust out of sample.

International diversification during financial crises

Purpose The purpose of this paper is to provide empirical evidence on how 1999–2001 dot-com crisis and 2007–2009 subprime crisis affect the gains from international diversification from the perspective of US investors. Design/methodology/approach A conditional international CAPM with asymmetric multivariate GARCH-M specification is used to estimate international diversification gains. Findings The authors find that over the entire sample period, the average gains from international diversification is statistically significant and about 1.253 percent per year. During the subprime crisis period, the average gains decreases to about 0.567 percent per year, but it increases to 2.829 percent per year during the dot-com crisis. Research limitations/implications These research findings although confirm the conjectures that international financial turmoil tends to increase the co-movements among global financial markets, are in contrast to the conjectures that international diversification does not work during the financial crisis as evidence from the dot-com crisis. Therefore, future research on international diversification should not just focus on the correlation among international financial markets and should adopt a fully parameterized asset pricing model to study this research topic. Practical implications Given the empirical results found in this paper that international diversification gains may be decreasing or increasing during the financial crisis, as long as investors are not able to predict international financial crises, it is the average gains from international diversification over the longer periods that should encourage investors to diversify, regardless of potentially lower benefits over the shorter periods of time. Originality/value The major value of this paper is that although the increase in the conditional correlation during the financial turmoil is consistent with previous studies, the empirical results clearly show that the impact of a financial crisis on the gains from international diversification cannot be solely determined by the correlation between domestic and world stock market returns since the gains also depend on the unsystematic risk from the domestic stock market. Consequently, it is premature for previous studies to conclude that the gain from international diversification is diminishing due to an increasing correlation among international stock markets during the financial crisis.

Markov Switching International Capital Asset Pricing Model, an Emerging Market Case: Mexico

The article shows how the international capital asset pricing model (ICAPM) with Markov regime switching can model the asset returns in the emerging market of Mexico. For most assets, although significant, the international risk premium factor is not subject to regime switching, but the domestic factor is. The probabilities of regimes are correlated with the volatility of assets. A GARCH(1,1) Markov regime switching model offers better adjustment than a non-GARCH. JEL Classification: C58, F36, F65, G12, G15

What Drives the Stock Market Comovements between Korea and China, Japan and the U.S.?

This paper measures the extent of comovements in stock returns between Korea and three major countries (China, Japan and the U.S.) using industry-level data for Korea from 2003 to 2016 in the spirit of the international capital asset pricing model. It also examines what drives the comovements between Korea and the three countries. We find that the comovements of Korean stock returns with those of the U.S. and Japan became smaller after the global financial crisis. In contrast, the comovement in stock returns between Korea and China became larger after the crisis. After an additional analysis, we conclude that trade linkage is the main driver of the comovements between Korea and the three countries.

What Drives the Stock Market Comovements between Korea and China, Japan and the US?

This paper measures the extent of comovements in stock returns between Korea and three major countries (China, Japan and the US) using the industry-level data for Korea from 2003 to 2016, in the spirit of the international capital asset pricing model. It also examines what drives the comovements between Korea and the three countries. We find that the comovements of the Korean stock returns with those of the US and Japan became smaller after the global financial crisis. In contrast, the comovement in stock returns between Korea and China became larger after the crisis. After an additional analysis, we conclude that trade linkage is the main driver of the comovements between Korea and the three countries. Our finding suggests that the concentration of trade with some trading partners can be a destabilizing factor in the domestic financial market if there is a negative shock to trade with those partners. Thus, it is important for Korea to diversify trade with foreign countries to keep its financial market more stable.

Country Risk Analysis of Pakistan: Evidence from Karachi Stock Exchange

This study analyzes the country risk of Pakistan by employing the international capital asset pricing model (ICAPM) framework for the time period of July 2000 to June 2015. This study has used the country beta approach to examine the country risk based on the local as well as the global economic indicators. The study includes one domestic variable; foreign exchange reserves (cash holdings) and three global variables; real foreign exchange rate, gold prices, and oil prices to examine the impact of these economic factors on country risk by employing Beta market approach. The empirical results of this study conclude that time-varying beta in Pakistan is affected by the global economic factors as well as the domestic economic factors and hence support the international capital asset pricing model in case of Pakistan. The findings of the study suggest that the international investors can frame out the hedging policy against country risk in measuring investment return and that an effective monetary and fiscal policy can be designed by considering the relationship of macroeconomic factors with country risk.

Applying an international CAPM to herding behaviour model for integrated stock markets

Applying an international CAPM to herding behaviour model for integrated stock markets

Global Market Integration Reversals and Funding Liquidity

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.

Comparison of Cost of Equity Models: New International Evidence

For individual stocks of 46 countries, this study investigates empirical differences in discount rate estimates between three risk-return models of interest to managers who perform discounted cash flow valuation analysis: (1) the traditional (local) CAPM; (2) the global CAPM (GCAPM), where the only risk factor is the global market index; and (3) an international CAPM (ICAPM) with two risk factors, the global market index and a wealth-weighted foreign currency index. The study finds that model choice makes a substantial difference for many, but not all, countries.

The Degree of Home Bias in the Holding of Share Portfolio

The objective of this paper is to measure the degree of Home Bias within the holdings of portfolio and to identify their determining factors. By following an intuitive reasoning, the authors have chosen a number of susceptible factors that have an impact on Home Bias. In fact, they have developed an international CAPM (Capital Asset Pricing Model). This model is estimated for 20 countries, with the use of cross-section econometrics. The authors' results show that all countries have recorded a high level of Home bias in their holdings of portfolio. In order to study whether the Home Bias of the newly emerging markets and that of the developed markets react differently to the determining factors or not the authors have evaluated the model so much jointly for all markets as separately for the developed and the newly emerging ones. In the case of classification of the sample, the results have permitted us to draw an important conclusion and to have cognizance that the volatility of the exchange rate is statistically significant concerning the newly emerging economies at a threshold of 1%, while it is hardly remarkable for the developed countries. This means that this variable prevents the American investors from investing in the former countries. Samely, for both variables of joint- variance and size.

The pricing of common exchange rate factors in the U.S. equity market

We extend Lustig et al. (Rev Financ Stud 24:3731–3777, 2011) and Brusa et al. (The International CAPM Redux, 2014) by examining if the common exchange rate factors, the dollar and carry factors, are priced in the US equity market. Our results suggest that while the carry factor has incremental pricing information relative to the US market factor, the dollar factor (or the trade-weighted exchange rate index) is redundant. Our results have important theoretical as well as practical implications. Theoretically, we suggest that financial economists take an endogenous perspective of exchange rates. Practically, we suggest that practitioners incorporate in the carry factor to measure the exposure of exchange rate risk.

An Exploration of the Time-varying Beta of the International Capital Asset Pricing Model: The Case of the Japanese and the Other Asia-Pacific Stock Markets

This study clarifies the state of dynamic evolution of the international CAPM betas for Asia Pacific (excluding Japan) and Japanese stock returns: first, both for Asia Pacific and Japanese stock markets, the time-invariant international CAPM beta values are not high. Second, over the period from July 2, 1990 to May 30, 2016, for Asia Pacific stock markets, the time-varying international CAPM betas gradually increase; while for the Japanese market, the time-varying international CAPM betas gradually decrease. We also find that the international time-varying CAPM betas for Japan are recently lower than those for Asia Pacific markets, thus, in the global equity investments, Japanese equities are more useful to obtain the diversification effects than the other Asia Pacific equities.

A Quantitative Investigation of the Time-varying Beta of the International CAPM: The Case of North American and European Equity Portfolios

This paper investigates the time-invariant and the time-varying betas of the international capital asset pricing model (CAPM) for North American and European equity portfolio returns over the period from August 1, 1990 to June 30, 2016. Our quantitative examinations using the full vector-half (VECH) model reveal the following interesting evidence. First, we find that (1) the time-invariant international CAPM beta value for North American equity portfolio returns and that for European equity portfolio returns, which are derived from the standard ordinary least squares (OLS) method, are both close to one. In contrast, our examinations find that (2) the time-varying international CAPM betas of North American equity portfolio returns are lower than one before 1996, and slightly higher than one after 1996. Moreover, our investigations further reveal that (3) the time-varying international CAPM betas of European equity portfolio returns are lower than one before around 2004, and clearly higher than one after around 2004.

CAPM with various utility functions: Theoretical developments and application to international data

This paper presents an extension of the Capital Assets Pricing Model (hereafter CAPM) where various utility functions are applied. Specifically, we propose an overall CAPM beta that accounts for the higher order moments and reflects the investor preferences and attitudes toward risk. We particularly develop CAPM betas for different classes of utility function: the negative exponential utility function, power utility function or “Constant Relative Risk Aversion (CRRA) Utilities” and hyperbolic utility function or “HARA Utilities” (hyperbolic absolute risk aversion). In order to validate our theoretical results, we analyze the impact of investors’ preferences on the valuation equation. Applying the International CAPM, the results indicate that our utilities-based betas differ largely from the traditional CAPM betas. Moreover, the results confirm the importance of higher order moments on the pricing equation. Finally, the results both empirically and theoretically post to the consistent effect of the risk av...

ASEAN Plus Three Stock Markets Integration

This paper examines the role played by local and international factors in the international integration process to stock markets worldwide. Using a sample of ASEAN + 3 (Association of South East Asian Nations + China, Korea and Japan) during the period between 2000 and 2014, we identify the main factors that might influence regional integration of stock markets. We propose an advantageous econometric approach based on a conditional version of the Dynamic International Capital Asset Pricing Model (ICAPM) to explore major sources of time-varying risks. We specifically apply the multivariate BEKK-GARCH process of Cappiello et al. (Journal of Financial Econometrics 25:537–572, 2006) to simultaneously estimate the ICAPM for each country. The study puts in evidence that regional trade openness, regional and world industrial production, dividend yields and commodity prices are among the key determinants of regional integration in the ASEAN + 3 context whatever is the measure of exchange rate risk.

Does Bilateral Market and Financial Integration Explains International Co-Movement Patterns1

This study aims to explore the relationship between market integration, foreign portfolio equity holding and inflation rates on international stock market linkages between Pakistan and India. To measure stock equity interlinkage, we constructed international co-movement index through rolling beta estimation. Market integration variable between these two countries is constructed using the International Capital Asset Pricing Model (ICAPM). To check the impact of market integration, foreign portfolio equity holding and inflation rate on Pakistan-Indian stock market co-movement, we applied autoregressive distributed lag (ARDL) estimation. ARDL estimation is applied due to different stationarity levels of the included variables. The level of convergence speed is measured by the introduction of error correction term (ECT) followed by variance decomposition analysis. Results of the study indicated presence of long term relationship among the included variables along with significance variance in bilateral co-movement due to inflation rate differential. The significance of inflation rate differences between these two countries are in accordance with portfolio balance theory stating that investors possess information about the macroeconomic variables thereby readjusting their portfolios for effective diversification.

Assessing Euro crises from a time varying international CAPM approach

Abstract This paper initially reviews the current empirical literature on the euro exchange rate. We consider the relationship between the euro and other floating currencies in terms of excess returns on bond markets and also the relationship between the euro–dollar and the US and European equity markets. One novelty in the paper is to consider the variation in the euro–dollar rate from an international capital asset pricing model (CAPM) perspective. The second new innovation is to use a kernel weighted time varying parameter regression approach which allows structural parameters and risk premium terms to evolve over time. We find evidence that the euro–dollar rate is substantially influenced by equity markets in the US and in the Eurozone.

Basileia III: Impacto para os Bancos no Brasil

RESUMO Este artigo avalia os possíveis impactos decorrentes da mudança do capital requerido dos bancos no Brasil, com a implantação do Acordo de Basileia III. Para tanto, foi utilizada uma amostra de 58 bancos, que compreende 80% dos ativos do Sistema Financeiro Nacional, segundo os balanços de dezembro de 2012. A metodologia adotada simulou a necessidade de capital regulatório que será exigida ao final do período de transição, em 2019, considerando a continuidade dos ativos ponderados pelo risco (APR) contido nesses balanços. Assumindo que alguns bancos irão recorrer ao mercado de capitais para elevar sua capitalização, foram analisados os retornos sobre o patrimônio (return on equity - ROE) nos últimos três anos, comparados ao custo de capital próprio, estimado pelo modelo internacional de precificação de ativos de capital (international capital asset pricing model - ICAPM). Constatou-se que 23 instituições apresentaram algum tipo de desenquadramento ao novo capital regulatório, dentre as quais os 3 maiores bancos públicos federais. Verificou-se, também, que 39 bancos apresentam ROE insuficiente para atrair novos investidores. A análise conjunta da adequação da estrutura de capital e do nível de retorno pode identificar eventuais vulnerabilidades. Conclui-se que a implantação do Acordo de Basileia III no Brasil pode intensificar a busca por maior eficiência e lucratividade. Em um futuro cenário, o sistema bancário brasileiro pode observar uma onda de fusões e aquisições e o crescimento do número de ofertas públicas iniciais (initial public offerings - IPOs).

The world market risk premium and U.S. macroeconomic announcements

Conditional tests of the International CAPM in previous studies (e.g., Harvey, 1991) help identify predictability but not causality. In this paper, we take an event-study approach to examine if the world market risk premium is particularly higher on prescheduled US macroeconomic announcement days. Empirically, we apply the Savor and Wilson (2014) methodology to daily US stocks as well as foreign stocks cross-listed in the US. Our findings suggest that there is a causal relationship from the state of the global economy to the world market risk premium.

Measures of Equity Home Bias Puzzle

The paper develops measures of home bias for 46 countries over the period 2001 to 2011 by employing various models: International Capital Asset Pricing Model (ICAPM), Mean-Variance, Minimum-Variance, Bayes-Stein, Bayesian and Multi-Prior. ICAPM country portfolio weights are computed relative to world market capitalization. Bayesian model allows for various degrees of mis-trust in the ICAPM and Multi-Prior model’s investors’ ambiguity aversion. Mean-Variance computes optimal weights by sample estimates of mean and covariance matrix of sample return and Bayes-Stein improves precision associated with estimating the expected return of each asset. Paper finds that, for few countries, there is not much change in home bias measures using various models. Foreign listing, idiosyncratic risk, beta, inflation, natural resources rents, size, global financial crisis and institutional quality have significant impact on home bias. There are policy implications associated with home bias.