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Information and the Equity Premium

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Author Info
Edward Schlee () (W. P. Carey School of Business Department of Economics)
Christian Gollier (No affiliation)

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Abstract

We consider the effect of information on the average risk-free rate and the average equity premium in a standard two-period exchange economy with complete markets and a representative agent. We show that information always increases the average risk-free rate. Clearly, perfect information eliminates the equity premium; moreover, we show that a particular kind of information about the level of the return to equity always decreases the average equity premium. Surprisingly, however, information must sometimes raise the premium, no matter what the preferences of the representative agent; and information purely about the volatility of the return always raises the equity premium for a interesting class of preferences. We use these results to illuminate the equity premium and risk-free rate puzzles.

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Paper provided by Department of Economics, W. P. Carey School of Business, Arizona State University in its series Working Papers with number 2133505.

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Find related papers by JEL classification:
D8 - Microeconomics - - Information, Knowledge, and Uncertainty
D9 - Microeconomics - - Intertemporal Choice and Growth
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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  4. Roland Bénabou & Jean Tirole, 2002. "Self-Confidence And Personal Motivation," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 871-915, August. [Downloadable!] (restricted)
  5. Pietro Veronesi, . "How Does Information Quality Affect Stock Returns?," CRSP working papers 462, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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  7. Chew, Soo Hong, 1983. "A Generalization of the Quasilinear Mean with Applications to the Measurement of Income Inequality and Decision Theory Resolving the Allais Paradox," Econometrica, Econometric Society, vol. 51(4), pages 1065-92, July. [Downloadable!] (restricted)
  8. Guiso, Luigi & Jappelli, Tullio & Terlizzese, Daniele, 1994. "Income Risk, Borrowing Constraints and Portfolio Choice," CEPR Discussion Papers 888, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  12. Hadar, Josef & Seo, Tae Kun, 1990. "The Effects of Shifts in a Return Distribution on Optimal Portfolios," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(3), pages 721-36, August. [Downloadable!] (restricted)
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  14. Paul R. Milgrom, 1981. "Good News and Bad News: Representation Theorems and Applications," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 380-391, Autumn. [Downloadable!] (restricted)
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  15. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November. [Downloadable!] (restricted)
  16. Abel, Andrew B., 2002. "An exploration of the effects of pessimism and doubt on asset returns," Journal of Economic Dynamics and Control, Elsevier, vol. 26(7-8), pages 1075-1092, July. [Downloadable!] (restricted)
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  17. Kimball, Miles S, 1993. "Standard Risk Aversion," Econometrica, Econometric Society, vol. 61(3), pages 589-611, May. [Downloadable!] (restricted)
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  18. Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1992. "Waiting to Invest: Investment and Uncertainty," Journal of Business, University of Chicago Press, vol. 65(1), pages 1-29, January. [Downloadable!] (restricted)
  19. Franke, Gunter & Stapleton, Richard C. & Subrahmanyam, Marti G., 1998. "Who Buys and Who Sells Options: The Role of Options in an Economy with Background Risk," Journal of Economic Theory, Elsevier, vol. 82(1), pages 89-109, September. [Downloadable!] (restricted)
  20. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March. [Downloadable!] (restricted)
  21. Kim, Tong Suk & Omberg, Edward, 1996. "Dynamic Nonmyopic Portfolio Behavior," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 9(1), pages 141-61. [Downloadable!] (restricted)
  22. Narayana R. Kocherlakota, 1996. "The Equity Premium: It's Still a Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(1), pages 42-71, March. [Downloadable!] (restricted)
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  23. Ogaki, Masao & Zhang, Qiang, 2001. "Decreasing Relative Risk Aversion and Tests of Risk Sharing," Econometrica, Econometric Society, vol. 69(2), pages 515-26, March.
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  24. John Y. Campbell & Luis M. Viceira, 2001. "Who Should Buy Long-Term Bonds?," American Economic Review, American Economic Association, vol. 91(1), pages 99-127, March. [Downloadable!] (restricted)
    Other versions:
  25. Pietro Veronesi, . "How Does Information Quality Affect Stock Returns?," CRSP working papers 361, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  26. Edward E. Schlee, 2001. "The Value of Information in Efficient Risk-Sharing Arrangements," American Economic Review, American Economic Association, vol. 91(3), pages 509-524, June. [Downloadable!] (restricted)
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