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

The Accounting Review · 2014 · Volume 89 · Issue 1

Abstract

In an incomplete market with heterogeneous prior beliefs, we show that public information can have a substantial impact on theex antecost of capital, trading volume, and investor welfare. The Pareto efficient public information system is the system enjoying the maximumex antecost of capital and the maximum expected abnormal trading volume. Imperfect public information increases the gains-to-trade based on heterogeneously updated posterior beliefs. In an exchange economy, this leads to higher growth in the investors' certainty equivalents and, thus, a higher equilibrium interest rate, whereas theex anterisk premium is unaffected by the informativeness of the public information system. Similar results are obtained in a production economy, but the impact on theex antecost of capital is dampened compared to the exchange economy due to welfare-improving reductions in real investments to smooth the investors' certainty equivalents over time.

Keywords

heterogeneous beliefs, public information, dynamic trading, cost of capital, real effects, investor welfare

Enable JavaScript for citation tools and additional paper interactions.