The Cost of Equity in India: The Effects of Local and International Models on Equity Pricing

Abstract

This paper presents the first test of Indian-specific cost of equity measures: the capital asset pricing model (CAPM), global CAPM and an International Arbitrage Pricing Theory (IAPT) model. Using 312 firms weekly and 320 firms monthly derived from the Bombay Stock Exchange 500 Index, the firm tests the cost of equity under the three different models for both general Indian firms and Indian ADRs. This paper confirms the theory proposed by Stulz (1995), demonstrating that cost of equity is cheaper in global markets than in domestic markets. Both local CAPM and global CAPM conformed to theory, but IAPT results were highly irregular. This represents one of the largest and most recent studies of Indian equity capital and cost of equity model calculations to date. Significant differences in betas exist between the models. The results indicate that weekly data for the CAPM and global CAPM produce the most reliable equity calculations for Indian firms.

Keywords: global capital assets, pricing models, CAPMs, ADRs, American depository receipts, USA, United States, international arbitrage, pricing theories, equity costs, international models, local models, Bombay, stock exchanges, global markets, domestic markets, equity capital, beta differences

JEL Classification: F3