PRAGMATICS OF USING A MODIFIED CAPM MODEL FOR ESTIMATING COST OF EQUITY ON EMERGING MARKETS

##plugins.themes.bootstrap3.article.main##

##plugins.themes.bootstrap3.article.sidebar##

Published: Jul 29, 2016

  Vitaliy Semenyuk

Abstract

The aim of the work is to forming pragmatic recommendations for the development and implementation the modified CAPM model in the process of estimating the equity value on emerging markets. Original CAPM model allows estimating the cost of equity on the developed capital markets. At the same time it requires the information received on the market data basis. But, as show recent empirical research, the classical model does not always produce acceptable results of the equity estimation. In addition, CAPM model in its classical form can’t be used to estimate the cost of equity for countries with emerging markets. This is due with lower efficiency in emerging markets, with lower level of liquidity and capitalization, which makes the information obtained from these markets not entirely reliable. Therefore in practice are increasingly using different modification CAPM models, that allow consider for more specific factors which affect the cost of equity. These factors, which are not considered in the classical CAPM model, include the size of the corporation and country risk. The first factor is actual for developed and emerging markets and needed to account during the equity estimation and modification the CAPM model. Country risk is associated with differences and peculiarities of the economies different countries and in the first place should be taken into account when estimating the cost of equity in emerging capital markets, which are considered by investors as more risky for investment. This factor should also be taken into account in estimating the cost of equity. Methodology In the process of constructing a modified CAPM model, theoretical and methodological provisions were used, which are set out in the work R. Banz, G. Bekaert, M. Goedhart, R. Grabowski, R. Grinold, D. Vessels, A. Damodaran, M. Dempsey, J. Zhang, R. Ibbotson, P. Kaplan, T. Koller, K. Kroner, L. Kruschwitz, M. Long, A. Lofler, G. Mandl, M. Miller, F. Modilyani, K. Nunes, D. Peterson, S. Pratt, L. Siegel, Y. Fama, P. Fernandes, K. Harvey, D. Harrington, S. Hassett. Results In result of research received a modified CAPM model, which can be used to determine the cost of equity in developed and emerging capital markets. Practical implications Received model in result of research may have practical use in the process of estimating the equity value and designed to determine the rate of return required by investors for investing money in equity of corporations on emerging markets. Value/originality Described modified CAPM model takes into account the effect of a greater number of factors that determine the cost of capital on emerging markets and ensures a correct estimate of the equity value in absences of reliable information from emerging markets.

How to Cite

Semenyuk, V. (2016). PRAGMATICS OF USING A MODIFIED CAPM MODEL FOR ESTIMATING COST OF EQUITY ON EMERGING MARKETS. Baltic Journal of Economic Studies, 2(2), 135-142. https://doi.org/10.30525/2256-0742/2016-2-2-135-142
Article views: 392 | PDF Downloads: 374

##plugins.themes.bootstrap3.article.details##

Keywords

equity, build-up method, risk-free rate, industry risk premium, equity risk premium, country risk premium, idiosyncratic risk, fundamental measures.

References

Banz, R.W. (1981). The Relationship between Return and Market Value of Common Stocks. Journal of Financial Economics, 9: 3–18.

Bekaert, G., Harvey, C.R. (2014). Emerging Equity Markets in a Globalizing World. Rochester, NY: Social Science Research Network. Retrieved from: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2344817

Damodaran, A. (2010). Investicionnaja ocenka: instrumenty i metody ocenki ljubyh aktivov: Al'pina Pablisherz

Damodaran, A. (2012). Response to Damodaran’s Country Risk Premium: A Serious Critique. Business Valuation Review, 31(2-3): 85–86.

Damodaran, A. (2016). Personal site professor A. Damodaran. Retrieved from: http://pages.stern.nyu.edu/~adamodar/

Dempsey, M. (2013). The Capital Asset Pricing Model (CAPM): The History of a Failed Revolutionary Idea in Finance. Abacus, 49: 7-23.

Grabowski, R., Harrington, J., Nunes, C. (2015). International Valuation Handbook: A Guide to Cost of Capital. Retrieved from: http://eu.wiley.com/WileyCDA/WileyTitle/productCd-1119070252.html.

Fama, E.F. (1977). Risk-Adjusted Discount Rates and Capital Budgeting Under Uncertainty, Journal of Financial Economics, 5(1): 3– 24.

Fernandez, P. (2015). CAPM: An Absurd Model. Working paper. Retrieved from: http://ssrn.com/abstract=2505597

Hamada, R. S. (1972). The effect of the firm’s capital structure on the systematic risk of common stocks. Journal of Finance, 27: 435–452.

Hassett, S.D (2010). The RPF Model for Calculating the Equity Risk Premium and Explaining the Value of the S&P with Two Variables, Journal of Applied Corporate Finance 22 (2): 118–130.

Kruschwitz, L., Löffler, A., Mandl, G. (2012) Damodaran’s Country Risk Premium: A Serious Critique. Business Valuation Review, 31(2): 75–84.

Long, M. S., Zhang, J. (2004). Growth Options, Unwritten Call Discounts and Valuing Small Firms. EFA 2004 Maastricht Meetings Paper no.4057. Retrieved from: http://www.ssrn.com/abstract=556203

Ravi, J., Zhenyu, W. (1996). The Default Spread Model presented herein is based on The Conditional CAPM and the Cross-Section of Expected Returns. The Journal of Finance, 51(1): 3-53.

Sharpe, W.F. (1964). Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk. The Journal of Finance, 19(3): 425–442.