Multinational Finance, 6th Edition

Chapter 20International Asset Pricing

We dance round in a ring and suppose, But the Secret sits in the middle and knows.

— Robert Frost

This chapter develops several models for pricing international assets, beginning with the single-currency capital asset pricing model (CAPM). An international asset pricing model (IAPM) is then presented after adding a few assumptions to ensure that purchasing power parity holds across currencies. The appeal of these two asset pricing models is that an asset's risk is uniquely identified by its systematic risk or beta measured against the market portfolio of all risky assets. Unfortunately for the CAPM and IAPM, market model betas estimated with OLS regressions have almost no relation to mean returns.

In the absence of a relation between mean returns and market model betas, finance has maintained a steady search for models to explain returns to domestic and international assets. This search has led to models with global, regional, national, industry, currency, firm size, value, and momentum factors—often with time-varying coefficients. The chapter concludes with a discussion of contemporary asset pricing models—and the continuing search for factors that are related to mean returns.

20.1 The International Capital Asset Pricing Model (IAPM)

The Traditional Capital Asset Pricing Model

Before we develop an international version of the CAPM, we need to complete development of the traditional, single-currency CAPM shown in Exhibit 20.1. Chapter ...