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

Contemporary Accounting Research, volume 35, issue 4, 2018[10.1111/1911-3846.12362]

52 Pages Posted: 26 Apr 2015 Last revised: 7 Mar 2025

See all articles by Tzu-Ting Chiu

Tzu-Ting Chiu

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

Yuyan Guan

Nanyang Business School, Nanyang Technological University

Jeong-Bon Kim

Simon Fraser University; City University of Hong Kong

Date Written: August 29, 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 29, 2017). Contemporary Accounting Research, volume 35, issue 4, 2018[10.1111/1911-3846.12362], Available at SSRN: https://ssrn.com/abstract=2598957 or http://dx.doi.org/10.1111/1911-3846.12362

Tzu-Ting Chiu (Contact Author)

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

Helleveien 30
Bergen, 5045
Norway

Yuyan Guan

Nanyang Business School, Nanyang Technological University ( email )

52 Nanyang Ave
Singapore, 639798
Singapore

Jeong-Bon Kim

Simon Fraser University ( email )

8888 University Drive
Burnaby, British Colombia V5A 1S6
Canada

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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