Information, Uncertainty and the Cost of Capitalin a Mean-Variance Efficient Market

Journal of Business Finance and Accounting, Forthcoming

19 Pages Posted: 21 Feb 2013 Last revised: 15 Jan 2015

See all articles by David Johnstone

David Johnstone

University of Sydney Business School; Financial Research Network (FIRN)

Date Written: March 10, 2013

Abstract

Before information φ arrives, market observers must be uncertain whether the stock price conditioned on φ will be higher or lower than the current price. Otherwise there is an obvious arbitrage opportunity. By assuming this minimal condition of efficient markets, it is shown under the mean-variance CAPM that information which makes the future value of a firm more certain, in the sense that its perceived covariance with the market is reduced towards zero, can lead to a higher expected return on that asset. A less intuitive connotation is that it is theoretically possible that the required return on the stock will necessarily fall after observing signal φ, or (in other circumstances) that it will necessarily rise. In general, information that allows better discrimination between firms leads some firms to have higher costs of capital and other firms to have lower costs of capital. Less obviously, better discrimination between firms can induce a higher average cost of capital across the market.

Keywords: Information, uncertainty, efficient markets, risk premium, financial disclosure, accounting information, cost of capital

JEL Classification: D80, D81, G11, G14

Suggested Citation

Johnstone, David, Information, Uncertainty and the Cost of Capitalin a Mean-Variance Efficient Market (March 10, 2013). Journal of Business Finance and Accounting, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2220544 or http://dx.doi.org/10.2139/ssrn.2220544

David Johnstone (Contact Author)

University of Sydney Business School ( email )

Instute of Transport and Logistics Studies (C37)
The University of Sydney
Sydney, NSW 2133
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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