Non-Diversifiable Volatility Risk and Risk Premiums at Earnings Announcements

Abstract

This study seeks to determine whether earnings announcements pose non-diversifiable volatility risk that commands a risk premium. We find that investors anticipate some earnings announcements to convey news that increases market return volatility and pay a premium to hedge this non-diversifiable risk. In particular, we find evidence of risk premiums embedded in prices of firms' traded options that are significantly positively associated with the extent to which the firms' earnings announcements pose non-diversifiable volatility risk. In addition, we find that volatility risk premiums are concentrated among bellwether firms and result in predictable variation in option straddle returns around earnings announcements. Taken together, our findings show that some earnings announcements pose non-diversifiable volatility risk that commands a risk premium. JEL Classifications: M41; G12; G13; G14

Firm Fundamentals and Variance Risk Premiums

“…The results in column (2) suggest that larger firms have higher variance returns. This is consistent with findings in Barth and So (2014), who find that the variance risk premium is higher around earnings announcements for larger firms and industry leaders. However, the results in column (3) suggest that the relation between size and variance returns depends on the inclusion of the firm-specific drivers of variance returns.…”

“…Our empirical analyses provide evidence that accounting numbers inform investors about the priced risk of future cash flows. This analysis extends several prior studies (e.g., Barth and So, 2014;Han and Zhou, 2012,) by identifying firm-level characteristics that are associated with the time series and cross-sectional variation in variance risk premiums identified in those studies. It also represents an important contribution to the literature that examines the relation between firm characteristics and asset returns (e.g., Daniel and Titman, 1997;Haugen and Baker, 1996;Lewellen, 2014 among others) because it…”

“…We offer direct evidence that accounting numbers simultaneously inform investors about future cash flows as well as the risk of those future cash flows. Barth and So (2014) find that the variance risk premium is higher around earnings announcements for larger firms, industry leaders, and firms whose earnings are both more sensitive to aggregate earnings factors and convey more news. Han and Zhou (2012) find that stocks whose returns tend to be low when systematic volatility increases have higher variance risk premiums.…”

A Tough Act to Follow: Contrast Effects in Financial Markets

“…12 Most studies of information transmission in firm news announcements focus on the case of a positive correlation in news whereby A's positive surprise is good news for B. For example, Anilowski, Feng, and Skinner (2007) and Barth and So (2014) study "bellwether" firms whose news conveys similar information for other firms. 13 Fully rational investors in efficient markets should not react with a delay even if the interpretation of A's news for B's prospects depends on B's earnings surprise.…”

The Future of Financial Reporting: Insights from Research

“…There are several streams of research investigating the risk‐relevance of financial reporting amounts and disclosures. For example, there is research showing that there is risk—firm‐specific and systematic—associated with earnings announcements (e.g., Barth and So, ). Other research focuses on risk relating to financial assets, such as securitized assets (e.g., Barth et al ., ).…”