How markets forecast and "front run" information: Bayesian market efficiency

Abstract Bayesian investors, rather than waiting, infer a probability distribution over what will be in the company’s 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 to the precision or quality of the firm’s future financial reporting. The premium can be positive or negative, meaning that the firm affects its cost of capital up or down by its choice of information system or reporting quality. Conservative accounting or any source of anticipated future information that is predisposed to reveal unfavorable news more efficiently than favorable news adds to the firm’s current cost of capital.