Information, Diversification, and Cost of Capital
John S. Hughes
University of California at Los Angeles
The Cheung Kong Graduate School of Business
University of California, San Diego (UCSD) - Rady School of Management
December 16, 2004
AFA 2006 Boston Meetings Paper
We investigate the effects of information and diversification on cost of capital in a noisy rational expectations model. Assuming a factor structure for risky asset payoffs and two classes of investors, informed and uninformed, we show that in large economies the APT (Ross, 1976) holds and i) information from private signals about idiosyncratic shocks has no effect on cost of capital and ii) information from private signals about systematic factors affects cost of capital only through factor risk premiums; there is no effect on factor loadings. These results imply that there are no cross-sectional effects of information on cost of capital within large economies.
Number of Pages in PDF File: 54
Keywords: information, diversification, cost of capital
JEL Classification: G14, G13, G12
Date posted: February 7, 2005
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