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Accounting information and left-tail risk

Author

Listed:
  • Irfan Safdar

    (Widener University)

  • Michael Neel

    (University of North Texas)

  • Babatunde Odusami

    (Widener University)

Abstract

Several recent studies attribute stock price crashes to firms withholding bad news from financial disclosures before a stock price crash. Contrary to this notion, we find evidence of a robust link between information in a firm’s financial disclosures and potential left-tail risk. We document that the sophisticated equity options traders incorporate information derived from financial statements about left-tail risk into prices of out-of-the-money put options on a firm’s equity, implying that a firm’s financial disclosures contain significant information relevant to pricing expected crash risk. However, we find that stock market investors at large appear to overlook this link and fail to incorporate information in financial disclosures about left-tail risk into stock prices in a timely fashion, potentially contributing to the severity of the eventual crash. These findings contradict the notion that managers can fully conceal information pertinent to left-tail risks and highlight the role of potential errors by investors in processing accounting information pertinent to left-tail risks. Our study is amongst the first to link financial statement analysis to expected crash risk.

Suggested Citation

  • Irfan Safdar & Michael Neel & Babatunde Odusami, 2022. "Accounting information and left-tail risk," Review of Quantitative Finance and Accounting, Springer, vol. 58(4), pages 1709-1740, May.
    • Handle: RePEc:kap:rqfnac:v:58:y:2022:i:4:d:10.1007_s11156-021-01036-6
    DOI: 10.1007/s11156-021-01036-6
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    Cited by:

    1. Anna Agapova & Jagadison K. Aier & Zhanel DeVides, 2022. "Earnings patterns and managerial guidance," Review of Quantitative Finance and Accounting, Springer, vol. 59(3), pages 1173-1213, October.
    2. Hang Lin & Lixin Liu & Zhengjun Zhang, 2023. "Tail Risk Signal Detection through a Novel EGB2 Option Pricing Model," Mathematics, MDPI, vol. 11(14), pages 1-32, July.
    3. Chia-Chi Lu & Carl Hsin-han Shen & Pai-Ta Shih & Wei‐Che Tsai, 2023. "Option implied riskiness and risk-taking incentives of executive compensation," Review of Quantitative Finance and Accounting, Springer, vol. 60(3), pages 1143-1160, April.
    4. Wang, Chen & Xiong, Xiong & Shen, Dehua, 2022. "Tail risks, firm characteristics, and stock returns," Pacific-Basin Finance Journal, Elsevier, vol. 75(C).

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    More about this item

    Keywords

    Left-tail risk; Accounting information; Financial statement analysis; Market efficiency; Crash risk;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G40 - Financial Economics - - Behavioral Finance - - - General

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