Information and the cost of capital in a mean-variance efficient market

Authors

David Johnstone, University of SydneyFollow

RIS ID

115701

Publication Details

Johnstone, D. J. (2015). Information and the cost of capital in a mean-variance efficient market. Journal of Business Finance and Accounting, 42 (1-2), 79-100.

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 that leaves 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 further result 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.