Asset Pricing with Estimation-risk and Uncertain Information Quality
Rodney D Boehme
Wichita State University - Department of Finance, Real Estate & Decision Sciences (FREDS)
University of Houston - Department of Finance
Bartley R. Danielsen
North Carolina State University - Poole College of Management
Sorin M. Sorescu
Texas A&M University - Department of Finance
Januray 17, 2006
We derive a conditional CAPM in a general equilibrium model where investors face estimation-risk on mean returns, and learn from information of uncertain quality or precision. In equilibrium, the loading on market risk augments the standard beta with the random or information-dependent conditional covariance matrix of the unknown mean returns. Therefore, announcement effects on equilibrium asset prices can occur because of changes in the required rate of return due to event-induced variations in estimation-risk, rather than revisions in estimated cash flows. In support of this prediction, we find that firms initiating cash payouts through repurchases during 1988-2000 show significant reduction in the post-event betas and their standard errors. The model is consistent with post-earnings-announcement drifts, and generates refutable predictions on the deviation of cross-sectional expected returns from the unconditional CAPM. Quantitatively, numerical simulations with an appropriately calibrated version of the model indicate that information quality risk has a substantial effect on equilibrium asset prices.
Number of Pages in PDF File: 40
Keywords: Estimation-risk; Information quality; Conditional CAPM
JEL Classification: D83, D92, E22working papers series
Date posted: April 29, 2005
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