The Association between Idiosyncratic Risk and Private Information Acquisition

Abstract

This study investigates earnings and forecast uncertainty as determinants of firm-specific idiosyncratic risk. Earnings uncertainty generated by the accounting process is distinguished from the earnings forecast uncertainty generated by the analysts' search and use of private information. The former is measured by volatility of earnings and operating cash flows, while the latter is measured by the component of forecast dispersion that is unexplainable by other publicly available information. The empirical tests for in- and out-of-sample predictions of forecast uncertainty show that both earnings volatility and forecast uncertainty explain significant proportions of variation in idiosyncratic risk. The results are consistent for each year during the test period of nine years.

Keywords: Analysts forecast dispersion, earnings volatility, forecast uncertainty, nonsystematic risk

JEL Classification: M41