The Implications of Annual Report's Risk Sentiment for Future Earnings and Stock Returns

Posted: 14 Mar 2006

See all articles by Feng Li

Feng Li

Shanghai Advanced Institute of Finance, Shanghai Jiaotong University

Date Written: March 2006

Abstract

I examine the implications of corporate annual reports' risk sentiment for future earnings and stock returns. I measure the risk sentiment of annual reports by counting the frequency of words related to risk or uncertainty in the 10-K filings. I find that an increase in risk sentiment is associated with lower future earnings: Firms with a larger increase in risk sentiment have more negative earnings changes in the next year. Risk sentiment of annual reports can predict future returns in a cross-sectional setting: Firms with a large increase in risk sentiment experience significantly negative returns relative to those firms with little increase in risk sentiment in the twelve months after the annual report filing date. A hedge portfolio based on longing firms with a minor increase in risk sentiment of annual reports and shorting firms with a large increase in risk sentiment generates an Alpha of more than 10% annually measured using the four-factor model including the Fama-French three factors and the momentum factor.

Keywords: Annual report, risk sentiment, earnings, stock returns

JEL Classification: D80; G12, G14; M40

Suggested Citation

Li, Feng, The Implications of Annual Report's Risk Sentiment for Future Earnings and Stock Returns (March 2006). Available at SSRN: https://ssrn.com/abstract=890586

Feng Li (Contact Author)

Shanghai Advanced Institute of Finance, Shanghai Jiaotong University ( email )

211 West Huaihai Road
Shanghai, Shanghai 200030
China

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