Quantitative market risk disclosure, bond default risk and the cost of debt : why value at risk?

Abstract

This paper investigates the association of SEC-mandated quantitative market risk disclosure (SEC, 1997) with bond default risk and firms' costs of issuing new debt. I examine such an association by partitioning the sample firms based on their current hedging performance. The results indicate that the first quantitative market risk disclosure is associated with bond default risk and cost of issuing debt differently, depending on the success in hedging. After controlling for other market risk factors, default risk and cost of debt both increase for speculative and/or ineffective hedging firms, but bond default risk decreases for effective hedging firms. The results are robust to alternative measures of hedging and speculation. These findings highlight the importance of reporting the effectiveness of a firm's hedging strategy, as required under SFAS No. 133. The analyses also show that the reduction in bond default risk and cost of debt is observed more frequently with the value at risk format than with sensitivity analysis.