Stochastic Expected Return, Disclosure, and Implied Cost of Capital

45 Pages Posted: 3 Sep 2021 Last revised: 1 Feb 2023

See all articles by Jun Chen

Jun Chen

Chinese University of Hong Kong

John S. Hughes

University of California at Los Angeles

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management

Dan Yang

Beijing Foreign Studies University

Date Written: January 31, 2023

Abstract

There is ample evidence that expected return is stochastic as a consequence of changes in investors’ opportunity set induced by random states of nature. We show that the implied cost of capital is a biased measure of expected return positively related to idiosyncratic risks. In turn, firms with more disclosures are likely to be associated with more idiosyncratic risk unrelated to expected return in neoclassical asset pricing theory. Consistent with the predicted bias in implied cost of capital, we find positive associations between various measures of firm disclosures as proxies for idiosyncratic volatility and implied cost of capital having controlled for systematic risks through commonly employed factors. These findings are at odds with studies that suggest greater firm disclosures serve to reduce (implied) cost of capital.

Keywords: Disclosure, Implied cost of equity capital, Expected return

JEL Classification: G12, G14, M41

Suggested Citation

Chen, Jun and Hughes, John S. and Liu, Jun and Yang, Dan, Stochastic Expected Return, Disclosure, and Implied Cost of Capital (January 31, 2023). Available at SSRN: https://ssrn.com/abstract=3915323 or http://dx.doi.org/10.2139/ssrn.3915323

Jun Chen (Contact Author)

Chinese University of Hong Kong ( email )

12 Chak Cheung Street
Hong Kong
Hong Kong

HOME PAGE: http://junchen.website

John S. Hughes

University of California at Los Angeles ( email )

D410 Anderson Complex
Los Angeles, CA 90095-1481
United States
310-794-9553 (Phone)
310-267-2193 (Fax)

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States
858.534.2022 (Phone)
5858.534.0745 (Fax)

Dan Yang

Beijing Foreign Studies University ( email )

Beijng
100089
China

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
192
Abstract Views
1,180
Rank
291,782
PlumX Metrics