Partially segmented international capital markets and international capital budgeting

Evidence suggests that international capital markets are neither fully inte grated nor completely segmented. There is, however, currently no general me thod available for computing the required return on corporate investments i n such capital markets. This paper uses a model of partially integrated int ernational capital markets to derive optimal international capital budgetin g rules. We show how capital budgeting rules depend on the level of investo r costs to cross-border investment, both directly and also indirectly throu gh the portfolio specialization they induce. We explain how required return s differ for different companies raising capital in such markets and how th ese costs of capital may be estimated. We also explain how these difference s in required returns can be consistent with general equilibrium and the ef fect they have on incentives for foreign direct investment. (C) 2000 Elsevi er Science Ltd. All rights reserved.