Information and Heterogeneous Beliefs: Cost of Capital, Trading Volume, and Investor Welfare

Posted: 21 Jul 2011 Last revised: 25 Dec 2013

See all articles by Peter O. Christensen

Peter O. Christensen

Copenhagen Business School - Department of Finance

Zhenjiang Qin

University of Macau

Date Written: August 29, 2013

Abstract

In an incomplete market with heterogeneous prior beliefs, we show public information can have a substantial impact on the ex ante cost of capital, trading volume, and investor welfare. The Pareto efficient public information system is the system enjoying the maximum ex ante cost of capital and the maximum expected abnormal trading volume. Imperfect public information increases the gains-to-trade based on heterogeneously updated posterior beliefs. In an exchange economy, this leads to higher growth in the investors' certainty equivalents and, thus, a higher equilibrium interest rate, whereas the ex ante risk premium is unaffected by the informativeness of the public information system. Similar results are obtained in a production economy, but the impact on the ex ante cost of capital is dampened compared to the exchange economy due to welfare improving reductions in real investments to smooth the investors' certainty equivalents over time.

Keywords: heterogeneous beliefs, public information, dynamic trading, cost of capital, real effects, investor welfare

Suggested Citation

Christensen, Peter Ove and Qin, Zhenjiang, Information and Heterogeneous Beliefs: Cost of Capital, Trading Volume, and Investor Welfare (August 29, 2013). Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1891842 or http://dx.doi.org/10.2139/ssrn.1891842

Peter Ove Christensen

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark
+45 6140 3237 (Phone)

Zhenjiang Qin (Contact Author)

University of Macau ( email )

Macau
China

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