The Influence of Corporate Risk Exposures on the Accuracy of Earnings Forecasts

Abstract

We examine how corporations' exposures to interest rates, exchange rates, and commodity prices are related to investors' and analysts' expectations about firms' earnings. The results indicate that investors and analysts encounter difficulties estimating the earnings effects of the risk exposures that companies face. Stock returns around earnings announcements are associated with the magnitude of both recent quarter and lagged shocks to interest rates, exchange rates and commodity prices, especially for firms with large ex-ante exposures to these risks. Further, although intra-quarter revisions to analysts' forecasts do incorporate information about the earnings effects of the risk shocks, analysts' earnings forecasts do not fully resolve the uncertainty created by recent quarter and lagged shocks. Overall, the results suggest that analysts resolve between 28% and 56% of the total uncertainty created by interest rate, exchange rate, and commodity price shocks (the percentage reduction depends on the types and magnitudes of a given firm's exposures). The results are consistent with arguments that corporate financial risk exposures are not transparent to investors or analysts, and support recent research arguing that firms' hedging strategies consider this source of earnings uncertainty.

Keywords: risk exposures, risk management, analysts' forecasts, interest rate risk, exchange rate risk, commodity price risk, risk disclosures

JEL Classification: G12, G29, G32, M41