Source: Easley, D. & O'Hara, M. (2004) · Journal of Finance 59(4), 1553–1583 · doi:10.1111/j.1540-6261.2004.00672.x
TL;DR
Shows that the composition of information — how much is private versus public — affects a firm's cost of capital. In a multi-asset rational-expectations equilibrium, shifting information from public to private raises the required return (Proposition 3), because private-information risk is a form of systematic risk that uninformed investors cannot diversify away. This links market microstructure (informed trading) to asset pricing and gives firms a channel — disclosure, listing venue, analyst coverage — to influence their cost of capital.
The question
Standard asset-pricing models exclude information structure from required returns, yet disclosure standards, market microstructure, and analyst following are all believed to affect a firm's cost of capital. Can the public/private split of information be a priced risk factor?
The model
A multi-asset, noisy/partially-revealing rational-expectations equilibrium with public and private signals, informed and uninformed (CARA) investors, incomplete markets, and assets in positive per-capita supply.
For each stock k, the fraction of total information that is private is α_k. Informed traders condition on private signals; uninformed condition on prices and public signals but remain systematically on the wrong side of trades.
Proposition 2 gives the equilibrium expected return per share: the risk premium rises with risk aversion (δ) and per-capita supply (x_k) in the numerator, and falls with the total precision of prior + public + private information in the denominator. With perfect information the asset is risk-free; with imperfect information the premium is positive.
Key predictions
Proposition 3: for μ_k < 1, increasing the private share α_k (shifting information from public to private) strictly increases the equilibrium required return — uninformed investors demand compensation for the information disadvantage they cannot diversify away.
More public disclosure (raising public precision / lowering the private share) lowers the risk premium and hence the cost of capital.
Implication: cross-sectionally, stocks with more private-information risk should command higher expected returns.
Empirical status
The model motivates microstructure-based measures of information risk such as the probability of informed trading (PIN); related empirical work (Easley, Hvidkjaer & O'Hara) reports a PIN-return premium. Whether information risk is robustly priced is contested.
Limitations
A stylized equilibrium; the public/private information split is hard to identify empirically.
PIN estimation is noisy and debated, and later studies question the pricing of PIN, so the empirical bridge from theory to returns remains unsettled.
Key references
Easley, D. & O'Hara, M. (2004) — Information and the Cost of Capital — Journal of Finance
Easley, D., Kiefer, N., O'Hara, M. & Paperman, J. (1996) — Liquidity, Information, and Infrequently Traded Stocks (PIN) — Journal of Finance
Glosten, L. & Milgrom, P. (1985) — Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders — Journal of Financial Economics
Provenance: verified/generated from the paper's full text.
