Cost of Capital: an Approach of the Investor's Explanatory Capability

The paper models the effects between the investor's information explanatory capability (IEC) and the cost of capital theoretically basing on a new approach of the investor's IEC. The results show that the differences among investors' IEC are one of the major sources which affect the expected return required, namely the cost of capital on a security. Specially, when a new information release occurs, the higher the IEC of the investors taking as a whole, and the lower the information dominance of the professional investor over the non-professional one, the lower the influence of the professional investor's IEC may exert on the equilibrium price. The higher the professional one's IEC, and the larger the discrepancy of IEC between the professional and the non-professional, the higher the cost of capital. Furthermore, the cost of capital is assumed negatively related to the proportion of the professional investors.