Information Quality and Equity Premium in Production Economies

Abstract

We study the relation between information quality and equity premium in a production economy. We show that the precision of the public information has a negative relation with the size of equity premium of the economy. This result contradicts those obtained in pure exchange economies, for example, Veronesi (2000). In pure exchange economies, there is only price adjustment in response to innovations of information. In production economies, both price and quantity respond to innovations of information, it is the quantity adjustment channel makes our result different from that obtained in pure exchange economies. It is argued by some author, that the equity premium has declined over the last few decades. The results in this paper would provide a potential explanation of the fact, i.e. it is because of more precise information about the fundamentals of the economy.