Do FRR 48 Disclosures Reduce Investors' Uncertainty and Diversity of Opinion about Firms' Market Risk Exposures?: A Trading Volume Analysis

This paper examines whether mandated market risk disclosures under the SEC Financial Reporting Release No. 48 (FRR 48) provide useful information to investors regarding firms’ risk exposures. To provide evidence on this issue we investigate whether the SEC disclosures reduce investor uncertainty and diversity of opinion about the implications of market rate or price changes for firm value. We expect this reduced uncertainty and diversity of opinion to manifest itself in a decline in the amount of daily trading volume associated with market rate or price changes after the disclosures are made public. To test this hypothesis we introduce the trading volume risk response coefficient (TVRRC), which measures the association between daily movements in market rates or prices and the daily percentages of a firm’s shares traded, after controlling for other factors that affect trading volume. We examine whether downward shifts in the TVRRC occurred after the 10-K filing dates for a sample of firms that first made FRR 48 disclosures in their 1997 SEC reports. We find such downward shifts in the TVRRC for firms disclosing market risk information about interest rate, foreign currency exchange rate, and energy price exposures. We also test for differences in results across the three quantitative disclosure methods allowed by FRR 48 (tabular, sensitivity and value at risk). We find downward TVRRC shifts for firms reporting interest rate exposures using any of the three methods, but only for firms reporting sensitivity or value at risk for exposures to foreign currency exchange rates. To rule out alternative explanations for the results, we focus on two control samples: (1) the original disclosure sample in the year before the SEC rule was effective and (2) a non-disclosure sample consisting of firms subject to the SEC rule that did not make market risk disclosures in the first fiscal year the rule was effective. We do not find significant shifts in TVRRC around these 10-K filing dates in either sample. We therefore interpret the downward shifts in TVRRC for the first-time disclosers as evidence supporting the hypothesis that the SEC-mandated disclosures reduce investor uncertainty and diversity of opinion about the implications of market rate or price changes for firm value.