TY - JOUR
T1 - The Effect of Risk Factor Disclosures on the Pricing of Credit Default Swaps
AU - CHIU, Tzu-Ting
AU - GUAN, Yuyan
AU - KIM, Jeong-Bon
N1 - Full text of this publication does not contain sufficient affiliation information. With consent from the author(s) concerned, the Research Unit(s) information for this record is based on the existing academic department affiliation of the author(s).
PY - 2018/10
Y1 - 2018/10
N2 - This study examines the relation between narrative risk disclosures in mandatory reports and the pricing of credit risk. In particular, we investigate whether and how the SEC mandate of risk factor disclosures (RFDs) affects credit default swap (CDS) spreads. Based on the theory of Duffie and Lando (2001), we predict and find that CDS spreads decrease significantly after RFDs are made available in 10-K/10-Q filings. These results suggest that RFDs improve information transparency about the firm’s underlying risk, thereby reducing the information risk premium in CDS spreads. The content analysis further reveals that disclosures pertinent to financial and idiosyncratic risk are especially relevant to credit investors. In cross-sectional analyses, we document that RFDs are more useful for evaluating the business prospects and default risk of firms with greater information uncertainty/asymmetry. Overall, our findings imply that the SEC requirement for adding a risk factor section to periodic reports enhances the transparency of firm risk and facilitates credit investors in evaluating the credit quality of the firm.
AB - This study examines the relation between narrative risk disclosures in mandatory reports and the pricing of credit risk. In particular, we investigate whether and how the SEC mandate of risk factor disclosures (RFDs) affects credit default swap (CDS) spreads. Based on the theory of Duffie and Lando (2001), we predict and find that CDS spreads decrease significantly after RFDs are made available in 10-K/10-Q filings. These results suggest that RFDs improve information transparency about the firm’s underlying risk, thereby reducing the information risk premium in CDS spreads. The content analysis further reveals that disclosures pertinent to financial and idiosyncratic risk are especially relevant to credit investors. In cross-sectional analyses, we document that RFDs are more useful for evaluating the business prospects and default risk of firms with greater information uncertainty/asymmetry. Overall, our findings imply that the SEC requirement for adding a risk factor section to periodic reports enhances the transparency of firm risk and facilitates credit investors in evaluating the credit quality of the firm.
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U2 - 10.1111/1911-3846.12362
DO - 10.1111/1911-3846.12362
M3 - RGC 21 - Publication in refereed journal
SN - 0823-9150
VL - 35
SP - 2191
EP - 2224
JO - Contemporary Accounting Research
JF - Contemporary Accounting Research
IS - 4
ER -
