Information, Diversification, and Cost of Capital
54 Pages Posted: 7 Feb 2005
Date Written: December 16, 2004
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.
Keywords: information, diversification, cost of capital
JEL Classification: G14, G13, G12
Suggested Citation: Suggested Citation