Partially Segmented International Capital Markets and International Capital Budgeting

Abstract

Evidence suggests that international capital markets are neither fully integrated nor completely segmented. There is, however, currently no general method available for computing the required return on corporate investments with such capital markets. This paper uses a model of partially integrated international capital markets to derive optimal international capital budgeting rules. We show how capital budgeting rules depend on the level of costs to cross-border investment, both directly and also indirectly through the portfolio specialization they induce. We explain how required returns differ for different companies in such markets and how these 'costs of capital' may be estimated. We also explain how such differences in required returns can be consistent with general equilibrium and the effect they have on incentives for foreign direct investment.