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

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  • Peter O. Christensen

    ()
    (Aarhus University)

  • Zhenjiang Qin

    ()
    (Aarhus University and CREATES)

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    Abstract

    In an incomplete market setting with heterogeneous prior beliefs, we show that public information can have a substantial impact on the ex ante cost of capital, trading volume, and investor welfare. In a model with exponential utility investors and an asset with a normally distributed dividend, the Pareto efficient public information system is the system which enjoys the maximum ex ante cost of capital, and the maximum expected abnormal trading volume. The public information system facilitates improved dynamic trading opportunities based on heterogeneously updated posterior beliefs in order to take advantage of the disagreements and the differences in con?dence among investors. This leads to a higher growth in the investors?certainty equivalents and, thus, a higher equilibrium interest rate, whereas the ex ante risk premium on the risky asset is unaffected by the informativeness of the public information system. In an effectively complete market setting, in which investors do not need to trade dynamically in order to take full advantage of their differences in beliefs, the ex ante cost of capital and the investor welfare are both higher than in the incomplete market setting, but they are independent of the informativeness of the public information system, and there is no information-contingent trade.

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    File URL: ftp://ftp.econ.au.dk/creates/rp/12/rp12_22.pdf
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    Bibliographic Info

    Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2012-22.

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    Length: 58
    Date of creation: 04 2012
    Date of revision:
    Handle: RePEc:aah:create:2012-22

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    Web page: http://www.econ.au.dk/afn/

    Related research

    Keywords: Heterogeneous Beliefs; Public Information Quality; Dynamic Trading; Cost of Capital; Investor Welfare;

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