Recently, there has been considerable interest among accounting researchers in the relation between asymmetric information and cost of capital. A number of empirical studies document associations between risk premiums and proxies for asymmetric information such as earnings quality. However, the theoretical foundation for these studies has yet to be fully established. In this study, we consider the effects of private signals that are informative of both systematic factors and idiosyncratic shocks affecting asset payoffs in a competitive, noisy, rational expectations setting. Taking a large economy limit, we show that (1) risk premiums equal products of betas and factor risk premiums, irrespective of information asymmetries; (2) holding total information constant, greater information asymmetry leads to higher factor risk premiums and, thus, higher costs of capital; and (3) controlling for betas, there is no cross-sectional effect of information asymmetries on cost of capital. These results provide guidance in interpreting the findings of existing empirical work and suggest specifications helpful for future research.

Major events often trigger abrupt changes in stock prices and volatility. We study the implications of jumps in prices and volatility on investment strategies. Using the event‐risk framework of Duffie, Pan, and Singleton (2000) , we provide analytical solutions to the optimal portfolio problem. Event risk dramatically affects the optimal strategy. An investor facing event risk is less willing to take leveraged or short positions. The investor acts as if some portion of his wealth may become illiquid and the optimal strategy blends both dynamic and buy‐and‐hold strategies. Jumps in prices and volatility both have important effects.