How Does Information Quality Affect Stock Returns?

Authors

  • Pietro Veronesi


  • University of Chicago. I thank Nick Barberis, Gadi Barlevy, John Cochrane, George Constantinides, Domenico Cuoco, Per Stromberg, Luis Viceira, Francis Yared, and the seminar participants at Harvard University, the University of Chicago, the Università Bocconi (Milano), the 1998 WFA meetings, and the 1998 European Summer Symposium in Financial Markets (Gerzensee, Switzerland) for their comments. I especially thank René Stulz (the editor) and an anonymous referee for their thoughtful suggestions and comments. I am indebted to John Y. Campbell for his guidance on my Ph.D. dissertation, which this paper draws on. All errors are my own.

Abstract

Using a simple dynamic asset pricing model, this paper investigates the relationship between the precision of public information about economic growth and stock market returns. After fully characterizing expected returns and conditional volatility, I show that (i) higher precision of signals tends to increase the risk premium, (ii) when signals are imprecise the equity premium is bounded above independently of investors' risk aversion, (iii) return volatility is U-shaped with respect to investors' risk aversion, and (iv) the relationship between conditional expected returns and conditional variance is ambiguous.

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