Should managers estimate cost of equity using a two-factor international CAPM?

Purpose – The purpose of this paper is to assess how much difference it makes for US firms to use the two-factor ICAPM to estimate their cost of equity instead of a single-factor CAPM. Design/methodology/approach – For a large sample of US companies, the authors compare the empirical cost of equity estimates of a two-factor international CAPM with those of the single-factor domestic CAPM and the single-factor global CAPM. Findings – The authors find that the cost of equity estimates of the two-factor ICAPM are reasonably close to those of either single-factor model for US firms with low-to-moderate foreign exchange exposure; and second, perhaps surprisingly, for US firms with extreme foreign exchange exposure, that the cost of equity estimates of the two-factor ICAPM tend to be very close to those of the domestic CAPM, and even closer than to those of the single-factor global CAPM. Research limitations/implications – The paper's findings might prove useful to academic researchers wanting to resolve the seemingly contradictory empirical results on the pricing of FX risk. Practical implications – The findings will hopefully help managers decide whether they should go to the trouble of estimating a US firm's cost of equity with the two-factor international CAPM instead of a traditional single-factor CAPM. Originality/value – The paper extends the existing literature by focusing on the two-factor ICAPM, and finds some new and surprising empirical results.