International Asset Pricing Under Segmentation and PPP Deviations
We analyze the impact of both Purchasing Power Parity (PPP) deviations and barriers to international investment on asset pricing and investor's portfolio holdings. The freely traded securities are priced similarly to Adler and Dumas (1983) and command two premiums: a global market risk premium and an inflation risk premium. The securities that can be held by only a subset of the investors command two additional premiums; a conditional market risk premium in the vein of Errunza and Losq (1985) and a segflation risk premium from bearing inflation risk in the presence of barriers. Our model nests several existing international asset pricing models and thus provides a framework to distinguish empirically between competing models. We test the conditional version of our model for eight major emerging markets. We use global market and industry portfolios, US and UK traded closed-end country funds, American Depository Receipts and Global Depository Receipts to replicate the returns on unattainable securities. We find that the global market, the conditional market and the global exchange risks are significantly priced as in previous research. Our results also point to the importance of the segflation risk which is statistically and economically significant.