An Empirical Examination of the Relationship Between Bond Risk Premiums and Loss Contingency Disclosures

Abstract:     
Prior research on the relationship between loss contingency disclosures and equity market parameters implies that such disclosures may provide useful information to equity market participants. However, there is no empirical evidence on the relationship between loss contingency data and bond market parameters. Using methods from continuous-finance theory, we model risk premiums on new issues as a function of default risk, issue traits, the risk-free rate, the severity level of loss contingency disclosures, and the frequency of such disclosures. Our results imply that both the severity-level and frequency of reported contingencies are positively related to the magnitude of risk premiums assessed on new bond issues. In economic terms, a one unit increase in the severity level of a contingency disclosure increases the yield premium by .034 percentage points. Similarly, each additional contingency reported by the firm during our sample period increased the yield premium by .305 percentage points.

JEL Classification: M41, M45, G12

Accepted Paper Series