How Markets Forecast and "Front Run“ Information: Bayesian Market Efficiency

A common and widely accepted conclusion in rational expectations models of financial reporting is that a scheduled report (e.g., the annual company earnings statement) can not affect the firm's stock price or cost of capital until the result is reported. I argue that Bayesian investors, rather than waiting, infer a probability distribution over what might be in the report and re-price the stock based on that probability distribution. To allow for their uncertainty about the report's content and the resulting stock price, the asset pricing formula includes a risk premium related strictly to the precision or quality of the firm's financial reporting. That premium can be positive or negative, which means that the firm can affect its cost of capital up or down by its choice of information system.