The Effect of Mandatory Risk Factor Disclosures on the Pricing of Credit Default Swaps

This study examines how risk factor disclosures (RFDs) mandated by the Securities and Exchange Commission (SEC) affect the pricing of credit default swaps (CDS). We find that CDS spreads decrease after RFDs are made available in corporate filings, implying that RFDs improve transparency of firms’ financial reporting and reduce information risk premium contained in CDS spreads. Additional analyses suggest that RFDs are especially helpful for investors to evaluate the underlying risks and future prospects of firms with greater information uncertainty and higher likelihood of default. Consistent with Duffie and Lando’s (2001) model, we also document that the slope and concavity of the CDS spread-maturity relation become steeper after firms provide RFDs. Overall, our findings imply that the SEC’s mandate for a “risk factor” section in periodic reports enhances the content of corporate filings and has a positive information effect on the credit market.