Risk-Factor Disclosure and Asset Prices

Posted: 13 Feb 2018

See all articles by Mirko Stanislav Heinle

Mirko Stanislav Heinle

University of Pennsylvania - Accounting Department

Kevin Smith

Stanford University Graduate School of Business

Robert E. Verrecchia

University of Pennsylvania - Accounting Department

Date Written: January 31, 2018

Abstract

While researchers and practitioners alike estimate firms' exposures to systematic risk factors, the disclosure literature typically assumes that exposures are common knowledge. We develop a model where the firm's exposure to a factor is unknown, and analyze the effect of factor-exposure uncertainty on share price and disclosure about the exposure. We find that: (i) factor-exposure uncertainty introduces skewness and excess kurtosis in the cash-flow distribution relative to the commonly used normal distribution; (ii) risk--factor disclosure affects all moments of that distribution; and (iii) the pricing of higher moments affects the price response of disclosure and the incentives to disclose. For example, factor-exposure uncertainty may actually increase price when the uncertainty implies positive skewness in the cash flow distribution. Hence, a reduction in uncertainty through disclosure may increase cost of capital. We also extend our model to multiple firms and show that factor-exposure uncertainty manifests as uncertainty about a firm's CAPM beta.

Keywords: Factor loading, disclosure, capital markets

JEL Classification: G12, M41

Suggested Citation

Heinle, Mirko Stanislav and Smith, Kevin and Verrecchia, Robert E., Risk-Factor Disclosure and Asset Prices (January 31, 2018). The Accounting Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3114311

Mirko Stanislav Heinle (Contact Author)

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Kevin Smith

Stanford University Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Robert E. Verrecchia

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-6976 (Phone)
215-573-2054 (Fax)

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