Asset Pricing with Estimation-Risk and Uncertain Information Quality

We derive a conditional CAPM in a general equilibrium model where investors face estimation-risk on mean returns, and learn from information of uncertain quality or precision. In equilibrium, the loading on market risk augments the standard beta with the random or information-dependent conditional covariance matrix of the unknown mean returns. Therefore, announcement effects on equilibrium asset prices can occur because of changes in the required rate of return due to event-induced variations in estimation-risk, rather than revisions in estimated cash flows. In support of this prediction, we find that firms initiating cash payouts through repurchases during 1988-2000 show significant reduction in the post-event betas and their standard errors. The model is consistent with post-earnings-announcement drifts, and generates refutable predictions on the deviation of cross-sectional expected returns from the unconditional CAPM. Quantitatively, numerical simulations with an appropriately calibrated version of the model indicate that information quality risk has a substantial effect on equilibrium asset prices