The Effect of Risk Factor Disclosures on the Pricing of Credit Default Swaps

52 Pages Posted: 26 Apr 2015 Last revised: 17 Aug 2017

See all articles by Tzu-Ting Chiu

Tzu-Ting Chiu

Norwegian School of Economics (NHH) - Department of Accounting, Auditing and Law

Yuyan Guan

Nanyang Business School, Nanyang Technological University

Jeong-Bon Kim

City University of Hong Kong

Date Written: August 2017

Abstract

This study examines the relation between narrative risk disclosures in mandatory reports and the pricing of credit risk. In particular, we investigate whether and how the SEC mandate of risk factor disclosures (RFDs) affects credit default swap (CDS) spreads. Based on the theory of Duffie and Lando (2001), we predict and find that CDS spreads decrease significantly after RFDs are made available in 10-K/10-Q filings. These results suggest that RFDs improve information transparency about the firm’s underlying risk, thereby reducing the information risk premium in CDS spreads. The content analysis further reveals that disclosures pertinent to financial and idiosyncratic risk are especially relevant to credit investors. In cross-sectional analyses, we document that RFDs are more useful for evaluating the business prospects and default risk of firms with greater information uncertainty/asymmetry. Overall, our findings imply that the SEC requirement for adding a risk factor section to periodic reports enhances the transparency of firm risk and facilitates credit investors in evaluating the credit quality of the firm.

Keywords: Risk factor disclosure; Mandatory reporting; Credit risk; Credit default swap

JEL Classification: M41; M48; G11; G32

Suggested Citation

Chiu, Tzu-Ting and Guan, Yuyan and Kim, Jeong-Bon, The Effect of Risk Factor Disclosures on the Pricing of Credit Default Swaps (August 2017). Available at SSRN: https://ssrn.com/abstract=2598957 or http://dx.doi.org/10.2139/ssrn.2598957

Tzu-Ting Chiu (Contact Author)

Norwegian School of Economics (NHH) - Department of Accounting, Auditing and Law ( email )

Helleveien 30
N-5045 Bergen
Norway

Yuyan Guan

Nanyang Business School, Nanyang Technological University ( email )

Singapore, 639798
Singapore

Jeong-Bon Kim

City University of Hong Kong ( email )

Department of Accountancy
83 Tat Chee Avenue
Kowloon Tong
Hong Kong
852-3442-7909 (Phone)

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