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.
Keywords: CAPM, Capital Asset Pricing Model, country risk, correlation, cost of equity
References:
De Jong F., de Roon F.A. Time-varying market integration and expected returns in emerging markets. Journal of Financial Economics, 2005, vol. 78, no. 3, pp. 583–613. URL: Link
Johnson R., Soenen L. Equity Market Risk Premium and Global Integration. Journal of CENTRUM Cathedra, 2009, vol. 2, pp. 12–23.
Bekaert G., Campbell R.H. Emerging Equity Markets in a Globalizing World. URL: Link
Bekaert G., Campbell R.H., Lundblad C., Siegel S. What Segments Equity Markets? The Review of Financial Studies, 2011, vol. 24, iss. 12, pp. 3841–3890. URL: Link
Arouri M.H., Teulon F., Rault C. Equity Risk Premium and Regional Integration. International Review of Financial Analysis, 2013, vol. 28, pp. 79–85. URL: Link
Campbell R.H. Country Risk Components, the Cost of Capital and Returns in Emerging Markets. URL: Link
Damodaran A. Country Risk: Determinants, Measures and Implications. NYU Stern School of Business, 2020.
Chovancová B., Árendáš P., Slobodník P., Vozňáková I. Country risk at investing in capital markets – the case of Italy. Problems and Perspectives in Management, 2019, vol. 17, iss. 2, pp. 440–448. URL: Link.2019.34
Anatolyev S. A 10-year retrospective on the determinants of Russian stock returns. Research in International Business and Finance, 2008, vol. 22, no. 1, pp. 56–67. URL: Link
Jalolov M., Miyakoshi T. Who drives the Russian financial markets? The Developing Economies, 2005, vol. 43, iss. 3, pp. 374–395. URL: Link
Fedorova E.A., Pankratov K.A. [World financial market influence on the Russian stock market]. Audit i finansovyi analiz = Audit and Financial Analysis, 2009, no. 2, pp. 267–273. (In Russ.) URL: Link
Fedorova E.A. [Assessment of influence of stock markets of the USA, China and Germany on stock market of Russia]. Ekonomicheskii analiz: teoriya i praktika = Economic Analysis: Theory and Practice, 2013, no. 47, pp. 29–37. URL: Link (In Russ.)
Omar M. Al Nasser, Hajilee M. Integration of emerging stock markets with global stock markets. Research in International Business and Finance, 2016, vol. 36, pp. 1–12. URL: Link
Vatsa P., Basnet H., Mixon F. Stock market co-movement in Latin America and the US: Evidence from a new approach. Journal of Financial Economic Policy, 2021, vol. Ahead-of-print, no. Ahead-of-print. URL: Link
Sehrawat N., Kumar A. et al. Test of capital market integration using Fama-French three-factor model: Empirical evidence from India. Investment Management and Financial Innovations, 2020, vol. 17, iss. 2, pp. 113–127. URL: Link.2020.10
Salmanov O.N. [Dynamic correlations between the stock market indices of developed countries and the Russian stock market index]. Ekonomicheskii analiz: teoriya i praktika = Economic Analysis: Theory and Practice, 2019, vol. 18, no. 11, pp. 2103–2124. (In Russ.) URL: Link
Salmanov O.N., Babina N.V., Samoshkina M.V. et al. The effects of volatility and changes in conditional correlations in the stock markets of Russia and developed countries. Economic Annals, 2020, vol. 65, iss. 227, pp. 67–94. URL: Link
Fernandez P., Bañuls S., Acín P.F. Survey: Market Risk Premium and Risk-Free Rate used for 88 countries in 2021. IESE Business School Working Paper, 2021, 17 p. URL: Link
Graham J.R., Campbell H.R. The Equity Risk Premium in 2018. URL: Link
Fama E., French K. The Equity Premium. The Journal of Finance, 2002, vol. 57, iss. 2, pp. 637–659. URL: Link
Damodaran A. Equity risk premiums (ERP): Determinants, estimation and implications. 2018. URL: Link
Groenendijk M., Engelbrecht H., Van Baardwijk R. Equity Market Risk Premium – Research Summary. KPMG, 2019. URL: Link
Levi Y., Welch I. Best practice for cost-of-capital estimates. Journal of Financial and Quantitative Analysis, 2017, vol. 52, iss. 2, pp. 427–463. URL: Link
