Merton (1987) predicts that idiosyncratic risk should be priced when investors hold sub-optimally diversified portfolios, but empirical research has not been supportive of the theory. An overlooked assumption in Merton (1987) is that the predictions are predicated on frictionless markets, and in...

We theoretically and empirically investigate the role of information on the cross section of stock returns and firms' cost of capital when investors face estimation risk and learn from noisy signals of uncertain quality. The resultant equilibrium is an information-dependent conditional CAPM. We...

Miller (1977) hypothesizes that dispersion of investor opinion in the presence of short-sale constraints leads to stock price overvaluation. However, previous empirical tests of Miller's hypothesis have examined the valuation effects of only one of these two necessary conditions. We examine the...

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...

Early studies find that option introductions tend to raise the price of underlying stocks. More recent research indicates that post-1980 option introductions are associated with negative abnormal returns in underlying stocks. Other studies document increased short-sale activities following...

Merton [1987. A simple model of capital market equilibrium with incomplete information. Journal of Finance 42, 483-510] predicts that idiosyncratic risk should be priced when investors hold sub-optimally diversified portfolios, and cross-sectional stock returns should be positively related to...