Peter O. Christensen
Aarhus University
Zhenjiang Qin
Southwestern University of Finance and Economics
ABSTRACT: In an incomplete market with heterogeneous prior beliefs, we show that
public information can have a substantial impact on the ex ante cost of capital, trading
volume, and investor welfare. The Pareto efficient public information system is the
system enjoying the maximum ex ante cost of capital and the maximum expected
abnormal trading volume. Imperfect public information increases the gains-to-trade
based on heterogeneously updated posterior beliefs. In an exchange economy, this
leads to higher growth in the investors’ certainty equivalents and, thus, a higher
equilibrium interest rate, whereas the ex ante risk premium is unaffected by the
informativeness of the public information system. Similar results are obtained in a
production economy, but the impact on the ex ante cost of capital is dampened
compared to the exchange economy due to welfare-improving reductions in real
investments to smooth the investors’ certainty equivalents over time.
