Are Item 1A Risk Factors Priced?

Abstract

Public companies report “the most significant factors that make” their common stock ”speculative or risky” in section “Item 1A. Risk Factors” of their annual filings. This paper uses textual analysis to estimate common risks from Item 1A texts and study these risks’ effect on public companies stock returns. I find the textual relevance of common Item 1A risks to the cross-section of firms’ Item 1A texts predicts the cross-section of expected stock returns. A factor portfolio aggregating information about returns from fifty individual Item 1A risks has an average monthly return of 0.97% and a risk adjusted return of 1.06%. Factor portfolios for nineteen individual Item 1A risks have significant average returns. Eighteen individual Item 1A risks provide independent information about stock returns.

Keywords: stock returns, risk factors, item 1a

JEL Classification: G12, G18, G32