Estimation Risk, Information, and the Conditional CAPM: Theory and Evidence

We theoretically and empirically investigate the role of information on the cross section of stock returns and firms' cost of capital when investors face estimation risk and learn from noisy signals of uncertain quality. The resultant equilibrium is an information-dependent conditional CAPM. We...

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Bibliographic Details
Published in:The Review of financial studies 2008-05, Vol.21 (3), p.1037-1075
Main Authors: Kumar, Praveen, Sorescu, Sorin M., Boehme, Rodney D., Danielsen, Bartley R.
Format: Article
Language:English
Subjects:
Capital assets
Capital costs
CAPM
Dividends
Equilibrium
Financial economics
Financial information
Financial models
Financial portfolios
Financial risk
Foreign exchange rates
Investment decision
Investment risk
Investments
Investors
Macroeconomics
Modeling
Oil prices
Prices
Rates of return
Return on investment
Risk
Risk factors
Risk premiums
Stock prices
Stock returns
Stocks
Studies
Systematic risk
Volatility
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Summary:We theoretically and empirically investigate the role of information on the cross section of stock returns and firms' cost of capital when investors face estimation risk and learn from noisy signals of uncertain quality. The resultant equilibrium is an information-dependent conditional CAPM. We find strong empirical support for the model. Innovations in market volatility, oil prices, exchange rates, and dispersion of analysts' forecasts not only help explain the cross section of stock returns, but their influence depends on the stock's systematic estimation risk. Moreover, dividend and share repurchase initiations have significant downward announcement effects on estimated betas and their standard errors.
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/hhn016