827
Appendix G
Global, International, and 
Local CAPM
The standard capital asset pricing model (CAPM), introduced in Chapter 15, 
for estimating the cost of capital, does not explicitly account for foreign assets, 
foreign investors, or currencies. This raises the question whether such a model 
can provide the right cost of capital for investments in foreign currencies. If 
foreign-currency rates are changing, the same investment will generate differ-
ent returns to investors from different countries. Take the case of a German 
government bond denominated in euros. From the perspective of a German 
or Dutch investor, this bond generates a risk-free return (assuming there is no 
inflation), because the euro is also the investor’s domestic currency. But the 
bond’s return is not risk free for investors in the United States, because the re-
turn measured in U.S. dollars will vary with the dollar-to-euro exchange rate.
As a general rule, investors from countries with different currencies are 
likely to disagree about an asset’s expected return and risk. In theory, this 
means that the standard CAPM no longer holds, and a more complex, interna-
tional CAPM is required. In practice, however, we find that the CAPM-based 
approach as laid out in Chapter 15 is still valid for estimating the cost of capi-
tal for cross-border investments. This appendix provides further background 
for our recommendations and practical guidelines for estimating the cost of 
capital in foreign currency.

828  Appendix G
Global CAPM
Investors’ disagreement about the return and risk of international investments 
disappears if purchasing power parity (PPP) holds across all currencies. In 
that case, changes in exchange rates perfectly match differences in inflation 
between currencies:1
X
X
i
i
t
t
A
B
=
+
+






−1
1
1
where 
X
B
A
t = exchange rate of currency
expressed in units of
currency
at time
inflation rate for currency
t
i
i
A B
A
B
,
,
=
As a result, the expected return and risk in real terms for any asset will be 
the same for all investors, regardless of their domestic currency. In the German 
bond example, any appreciation of the U.S. dollar relative to the euro would 
make the nominal bond return for U.S. investors lower. But if PPP holds, the 
inflation rate in the United States would be lower by exactly the same amount, 
so the payoff in real terms for U.S. and German investors would be equal. In 
real terms, there is no currency risk for investors. They will all hold the same 
global market portfolio of risky assets and face the same real risk-free rate as 
if there were only a single currency.
The resulting so-called global CAPM is in fact the standard CAPM with a global 
market portfolio. It expresses the expected real return for an asset j as follows:
E r
r
E r
r
j
f
j G
G
f
( )
(
)
,
=
+
−


β
where 
r
j
r
j
j
f
j G
=
=
=
return for asset
risk-free rate
beta of asset
versus g
β ,
lobal market portfolio
return for global market portfolio
G
r
G
G =
According to the global CAPM, the cost of capital for domestic as well as foreign 
assets follows from the asset’s beta relative to the global market portfolio and 
the market risk premium of that market portfolio relative to the risk-free rate.
Technically, the global CAPM is valid only if PPP holds. Evidence on PPP 
has been mixed, but academic research appears to conclude that deviations 
1 Technically, this is so-called relative purchasing power parity, referring to changes in prices and ex-
change rates. Absolute purchasing power parity requires that prices be the same across currencies; 
see, for example, R. Brealey, S. Myers, and F. Allen, Principles of Corporate Finance, 13th ed. (New York: 
McGraw-Hill, 2020), chap. 27.