COVID-19 Paper: Risk Disclosure Increases Stock Return Volatility

How does the stock market react to risk disclosures in annual reports of firms? Are firms that disclose risks like a pandemic before they materialize better off? With share prices of such firms dropping when a risk case such as a pandemic occurs, the contrary would appear to be true. However, there is one exception. A clearly positive effect has been detected when there is good news regarding the disclosed risk at hand. These findings were recently published in a KLU paper by PhD candidate Keno Theile, Prof. Kai Hoberg, and Prof. Alexander Himme.

The researchers examined which companies disclosed the risk of an epidemic or pandemic in their annual reports filed in 2019, and what consequences this action has had on the firms’ stock returns now that the risk materialized during the COVID-19 crisis.

Significant Increase in Stock Return Volatility

Across all industries, only 19 % of US firms in the set warned about the risk of a pandemic. Those firms had a higher stock return volatility when the COVID-19 crisis unrolled, meaning that they were perceived riskier by investors. Extraordinary events had a significantly greater negative impact on firms that disclosed their risk. One example is when the travel ban to Europe was announced mid-March 2020. However, in turn, these same firms profited more from good news, for example when the US government announced a two trillion-dollar stimulus package shortly after the travel ban.

First Study About Materialized Risk

Previous studies had investigated the reactions to the information at the time of disclosure. Still, there is little evidence about the differences between the market reaction to firms disclosing the risks and firms which do not when the risks indeed materialize. “By using the COVID-19 pandemic, we are able to provide empirical evidence about the effect of a disclosed systematic risk on the stock market returns across a broad set of industries. However, the causality can only be explained in a retrospective after the financial market has stabilized and the realized financial impacts of the pandemic on each firm have fully evolved and have been reported,” concluded Keno Theile.

More than 3,400 annual reports filed in 2019 of companies listed on U.S. stock exchanges were analyzed to deliver risk disclosure data. The time of stock exchange observation spans from January to June 2020.

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