Measuring Risk Information

Abstract

We develop a measure of how information events impact investors' expectations of risk that is broadly applicable and simple to implement. We derive this measure from an option-pricing model where investors anticipate an announcement that simultaneously conveys information on the announcer's expected future cash flows and risk profile. We empirically implement the measure using firms' earnings announcements, showing that it closely aligns with our model's predictions and offers strong forecasting power for firms' risk profiles, costs of capital, and future investments. We further highlight pitfalls of using simple changes in option-implied volatilities to study information gleaned from earnings announcements. Finally, we apply our measure toward studying disclosure regulation, the efficacy of text-based proxies, and market-wide events, providing novel evidence on the transmission, measurement, and implications of risk information.

Keywords: risk information, option prices, earnings announcements, volatility forecasting

JEL Classification: G10, G11, G12, G14, M40, M41