The Distribution of Information, the Market for Financial News, and the Cost of Capital

Recent empirical evidence suggests that stocks exhibiting a greater degree of asymmetric information among investors earn higher returns. By incorporating a market for financial news, this paper presents a rational... [ view full abstract ]

Recent empirical evidence suggests that stocks exhibiting a greater degree of asymmetric information among investors earn higher returns. By incorporating a market for financial news, this paper presents a rational expectations model consistent with this observation. When private information about a firm is highly concentrated within a small segment of the population, few individuals expect to hold a large enough stake in the firm to warrant purchasing a copy of firm-specific news. Given increasing returns to scale in news production, these few individuals find a copy of news prohibitively expensive to purchase, which prevents them from learning more about fundamentals and therefore raises their required risk premium. This result hinges crucially on the existence of competitive information markets, which suggests that the financial news media plays an important role in determining how the cost of capital varies with the inequality of information across investors.