The Cost of Equity in Emerging Markets: A Downside Risk Approach

Every company evaluating an investment project or an acquisition in an emerging market must not only estimate future cash flows but also an appropriate discount rate. Although not free from controversy, the cost of equity in developed markets is typically estimated with the CAPM. In emerging markets, however, betas and stock returns seem to be unrelated. This article argues that total risk, idiosyncratic risk, and some measures of downside risk are significantly related to emerging-market stock returns, and proposes to estimate costs of equity in these markets based on the semideviation with respect to the mean, a well-known measure of downside risk.

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