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RFS Advance Access originally published online on March 14, 2008
Review of Financial Studies 2008 21(3):1037-1075; doi:10.1093/rfs/hhn016
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© The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org

Estimation Risk, Information, and the Conditional CAPM: Theory and Evidence

Praveen Kumar
C.T. Bauer College of Business, University of Houston

Sorin M. Sorescu
Mays Business School, Texas A&M University

Rodney D. Boehme
Barton School of Business, Wichita State University

Bartley R. Danielsen
College of Management, North Carolina State University

Address correspondence to Praveen Kumar, University of Houston, C.T. Bauer College of Business, Houston, TX 77204-2016; telephone: (713) 743-4770; fax: (713) 743-4789; e-mail: pkumar{at}uh.edu

JEL Classification: D83, D92, E22


  Abstract

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 find strong empirical support for the model. Innovations in market volatility, oil prices, exchange rates, and dispersion of analysts' forecasts not only help explain the cross section of stock returns, but their influence depends on the stock's systematic estimation risk. Moreover, dividend and share repurchase initiations have significant downward announcement effects on estimated betas and their standard errors.

We thank an anonymous referee and the editor, Maureen O'Hara, for very helpful comments. We also thank Beth Allen, Suman Bannerjee, Kerry Back, Charles Cuny, Lou Ederington, Richard Green, Chitru Fernando, Mark Flannery, Evgenia Golubeva, Campbell Harvey, Scott Linn, Ronni Michaely, Ramon Rabinovitch, Michael Rebello, Bhaskar Swaminathan, Pradeep Yadav, and seminar participants at University of Oklahoma, Texas A&M University, and Tulane for useful comments or discussions on issues examined in this paper. All shortcomings are our own responsibility.


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