Measuring Risk Information

63 Pages Posted: 7 Feb 2020 Last revised: 16 Apr 2021

See all articles by Kevin Smith

Kevin Smith

Stanford University Graduate School of Business

Eric C. So

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: April 16, 2021

Abstract

We develop a measure of how information events impact investors' expectations of risk that is broadly applicable and simple to implement. We derive this measure from an option-pricing model where investors anticipate an announcement that simultaneously conveys information on the announcer's expected future cash flows and risk profile. We empirically implement the measure using firms' earnings announcements, showing that it closely aligns with our model's predictions and offers strong forecasting power for firms' risk profiles, costs of capital, and future investments. We further highlight pitfalls of using simple changes in option-implied volatilities to study information gleaned from earnings announcements. Finally, we apply our measure toward studying disclosure regulation, the efficacy of text-based proxies, and market-wide events, providing novel evidence on the transmission, measurement, and implications of risk information.

Keywords: risk information, option prices, earnings announcements, volatility forecasting

JEL Classification: G10, G11, G12, G14, M40, M41

Suggested Citation

Smith, Kevin and So, Eric C., Measuring Risk Information (April 16, 2021). Stanford University Graduate School of Business Research Paper No. 3519543, Available at SSRN: https://ssrn.com/abstract=3519543 or http://dx.doi.org/10.2139/ssrn.3519543

Kevin Smith (Contact Author)

Stanford University Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Eric C. So

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

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