The Cost of Equity Capital in Australia: What Can We Learn from International Equity Returns?

This paper reviews some evidence on the cost of equity capital in Australia and overseas. Two conventional approaches yield conflicting results. A third approach, based on the International Asset Pricing Model, starts from the premise that Australian equities are part of a world market, and hence must be priced in a manner that reflects their risk in an international context. There is evidence that Australian stockmarket returns show more risk than would be justified by the relatively low debt/equity ratios of Australian companies. Furthermore, real earnings in Australia appear to have been relatively risky when measured against the benchmark of world earnings. If there is more risk in the Australian economy, it is possible that the cost of equity is higher in Australia than overseas.