The literature review concludes that there is no consensus regarding the most suitable international asset pricing model for calculating discount rates for emerging countries.
After reviewing the theoretical and applied literature on cost of capital determination and international asset pricing models, the paper identifies and applies methodologies to determine discount rates applicable to emerging markets for different countries and currencies and develops methodologies for empirically measuring exposure to the country credit risk factor.
For example, there are several international asset pricing models that calculate the returns required for various asset classes (Bekaert et al., 2011), and academic models do not account for the experience of practitioners (Abuaf, 2011).
This paper begins by presenting a review of the literature on international asset pricing models, offering also a summary of specific "frequent" practices, then develops a method for estimating the exposure to a second risk factor that relates to country risk, in addition to the estimating exposure to the traditional market risk factor or Beta.
INTERNATIONAL ASSET PRICING MODELS: THEORY AND PRACTICE
(2012) determined that, in addition to exposure to a global market portfolio, exposure to a global credit risk factor (measured as the difference between the equity returns for countries with low and high risk ratings) is significant for explaining the dispersion of returns among countries, reducing the errors in international asset pricing models, and underlining the importance of local factors.
In summary, given the evidence of increasing integration, it would be appropriate to use international asset pricing models to determine the cost of capital, with the first risk factor given by the exposure to global equity risk.
The next section presents an international asset pricing model in the presence of the shadow costs of incomplete information.
Up to now we have considered that the purchasing power party does not hold, in this case the international asset pricing model includes K + 1 risk premia, one for the global market portfolio, one for the valuation currency's own inflation and K-1 additional risk that reflect the other country's uncertain inflation.
All these theoretical models and empirical tests are consistent with our international asset pricing model with information costs, which explain the home bias equity in international finance.
Many international asset pricing models
have been proposed to explain this cross-country variation including the world capital asset pricing model (CAPM) (Cumby and Glen, 1990; Harvey, 1991; Ferson and Harvey, 1993, 1994), the global exchange rate risk model (Dumas and Solnik, 1995), and others.