Information and Capital Asset Pricing

Abstract

Investors in a market frequently update their diverse perceptions of the values of risky assets, thus invalidating the classic CAPM's assumption of compete agreement among investors. To accommodate information asymmetry and belief updating, we develop an information-adjusted CAPM, which states that the expected excess return of a risky asset/portfolio is solely determined by information-adjusted beta rather than market beta. The new model can successfully explain empirical anomalies of the classic CAPM, including a flatter relation between average return and market beta than the CAPM predicts, a non-zero Jensen's alpha, insignificant explanatory power of market beta, and size and value effects.

Keywords: Asset Pricing, Asymmetric Information, CAPM anomaly, Rational Expectations Equilibrium

JEL Classification: G100, G110, G120, G140