Changes in Risk Factor Disclosures and the Variance Risk Premium

This paper examines how changes in firms’ risk disclosures affect a key market measure of risk. Our proxy for changes in risk disclosures is the addition and removal of individual risk factors to firms’ 10-K annual filings, identified via textual analysis of the risk factors section. Our market measure proxy for risk is the variance risk premium (VRP), which captures the market’s pricing of uncertainty about the risks the firm faces. Following the theoretical predictions of recent literature, we expect that newly disclosed signals of risk-factor exposure—reflected in added and removed risk factors—decrease the uncertainty surrounding firm risk, as proxied via the VRP. Empirical results strongly support these predictions: greater changes in individual risk factors are related to a lower VRP. Importantly, our new proxy based on individual risk factors offers incremental insights as compared to aggregate textual measures (including of risk) based on word counts, examined in the prior literature. Collectively, our findings suggest that textually evaluating individual risk factors reveals information about the uncertainty regarding firm risk