Information Asymmetry, Information Precision, and the Cost of Capital
Review of Finance, 2011
Wharton Financial Institutions Center Working Paper No. 06-21
42 Pages Posted: 11 Oct 2006 Last revised: 25 Nov 2011
There are 3 versions of this paper
Information Asymmetry, Information Precision, and the Cost of Capital
Information Asymmetry, Information Precision, and the Cost of Capital
Information Asymmetry, Information Precision, and the Cost of Capital
Date Written: March 1, 2008
Abstract
The consequences of information differences across investors in capital markets are still much debated. This paper examines the relation between information differences across investors and the cost of capital, and makes three points. First, in models of perfect competition, information differences across investors affect a firm's cost of capital through investors' average information precision, and not information asymmetry per se. Second, the average information precision effect is unlikely to diversify away when there exist many firms whose cash flows covary. Thus, better disclosure can reduce a firm's cost of capital. Third, the precision effect does not give rise to a separate information risk factor. These points are important to empirical research in financial economics, as well as to regulators who debate future disclosure requirements and the consequences of prior requirements such as Regulation Fair Disclosure.
Keywords: Information risk, Cost of capital, Expected return, Asset pricing, Disclosure, Rational expectations, Diversification
JEL Classification: G12, M41, D82
Suggested Citation: Suggested Citation
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