The Effect of Asymmetric Information and Transaction Costs on Asset Pricing: Theory and Test

Abstract

This paper presents a capital asset pricing model in the presence of asymmetric information and transaction costs. The model is a generalized version of Merton's (1987) model and Black's (1974) model. Empirical tests show a negative relation between the expected rate of return and the shadow costs of incomplete information. The results in this paper have the potential to explain the home bias equity in a domestic and an international context.