Information Risk and Fair Values: An Examination of Equity Betas
Journal of Accounting Research, 49, no. 4: 1083–1122.
56 Pages Posted: 28 Jul 2009 Last revised: 19 Jul 2013
Date Written: 2011
Using a sample of U.S. financial institutions, we exploit recent mandatory disclosures of financial instruments designated as fair value level 1, 2, and 3 to test whether greater information risk in financial instrument fair values leads to higher cost of capital. We derive an empirical model allowing asset-specific estimates of implied betas, and find evidence that firms with greater exposure to level 3 financial assets exhibit higher betas relative to those designated as level 1 or level 2. We further find that this difference in implied betas across fair value designations is more pronounced for firms with ex ante lower quality information environments: firms with lower analyst following, lower market capitalization, higher analyst forecast errors, or higher analyst forecast dispersion. Overall, the results are consistent with a higher cost of capital for more opaque financial assets, but also suggest that differences in firm’s information environments can mitigate information risk across the fair value designations.
Keywords: banks, risk, fair value, financial instruments, SFAS 157
JEL Classification: G12, G14, G21, M41
Suggested Citation: Suggested Citation