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An asymmetric approach to the cost of equity estimation: empirical evidence from Russia

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  • Yury Dranev

    ()
    (National Research University Higher School of Economics)

  • Sofya Fomkina

    (National Research University Higher School of Economics)

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    Abstract

    The choice of an appropriate model for the estimation of the cost of equity in emerging markets is still a very challenging problem. Market inefficiency, limited opportunities for diversification, as well as liquidity issues inspire researches to look for risk characteristics beyond the traditional framework of the classical capital asset pricing model. Various models have been developed over the past several decades proposing new ways of risk assessment. However, the empirical evidence of these models requires careful consideration. Most asset pricing models were developed in terms of either a symmetric mean-variance or a folded mean-semivariance framework. These models have several drawbacks in capturing investors’ attitudes to stock price movements. We provide a brief description of the recently proposed entropic risk characteristics which assign greater weight to the downside movements of asset prices and smaller weight to the upside movements. The goal of this study is to determine which model has better explanatory power for returns in the Russian capital market. We compare the performance of risk measures in the Russian stock market on a dataset of 63 stocks for the period from 2003 to 2012. Empirical results show certain advantages of entropic risk characteristics over other risk measures in explaining returns on Russian equities.

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    File URL: http://www.hse.ru/data/2013/02/28/1307136519/12FE2012.pdf
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    Bibliographic Info

    Paper provided by National Research University Higher School of Economics in its series HSE Working papers with number WP BRP 12/FE/2013.

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    Length: 15 pages
    Date of creation: 2013
    Date of revision:
    Publication status: Published in WP BRP Series: Financial Economics / FE, February 2013, pages 1-15
    Handle: RePEc:hig:wpaper:12/fe/2013

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    Keywords: rate of return; cost of equity; CAPM; entropic variance.;

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    1. Swee-Sim, Foong & Kim-Leng, Goh, 2010. "Measuring the Cost of Equity of Emerging Market Firms: The Case of Malaysia," Asian Academy of Management Journal of Accounting and Finance, Penerbit Universiti Sains Malaysia, vol. 6(1), pages 25-46.
    2. Harvey, Campbell R, 1995. "Predictable Risk and Returns in Emerging Markets," Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 773-816.
    3. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
    4. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
    5. Barclay, Richard & Fletcher, Jonathan & Marshall, Andrew, 2010. "Pricing emerging market stock returns: An update," Emerging Markets Review, Elsevier, vol. 11(1), pages 49-61, March.
    6. Don Galagedera, 2009. "Economic significance of downside risk in developed and emerging markets," Applied Economics Letters, Taylor & Francis Journals, vol. 16(16), pages 1627-1632.
    7. Pereiro, Luis E., 2001. "The valuation of closely-held companies in Latin America," Emerging Markets Review, Elsevier, vol. 2(4), pages 330-370, December.
    8. Galagedera, Don U.A. & Brooks, Robert D., 2007. "Is co-skewness a better measure of risk in the downside than downside beta?: Evidence in emerging market data," Journal of Multinational Financial Management, Elsevier, vol. 17(3), pages 214-230, July.
    9. Stephen Godfrey & Ramon Espinosa, 1996. "A Practical Approach To Calculating Costs Of Equity For Investments In Emerging Markets," Journal of Applied Corporate Finance, Morgan Stanley, vol. 9(3), pages 80-90.
    10. Estrada, Javier, 2007. "Mean-semivariance behavior: Downside risk and capital asset pricing," International Review of Economics & Finance, Elsevier, vol. 16(2), pages 169-185.
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