In financial markets, asset prices are meant to reflect the value of the company. But other factors influence price – information being among the most important ones. Intuitively, having more information about a company’s performance should reduce uncertainty about its stock prices. However, the results of recent empirical studies ran contrary to this intuition. Our research indicates that the timing of information disclosures matters and that the impact of information on volatility is highly contingent on the elapsed time since the disclosure.

Major exchanges such as the Securities and Exchange Commission (SEC) require publicly traded companies to provide information in the form of reports known as 10-K reports in the United States (or the Annual Information Form in Canada). The 10-K documents a company’s history, organisational structure, financial statements, earnings per share, subsidiaries, executive compensation and other relevant data. The fundamental purpose of these mandatory annual filings is to provide information on the financial condition of the company and reduce uncertainty for investors. Therefore, in principle, the more information the report provides, the better it can reduce uncertainty. Our study shows, however, that this informational role is only revealed by learning over time.

The information effect

When companies provide financial information through reports such as 10-K filings, such information disclosures do not reduce uncertainty immediately. 

To put things in perspective, it takes an experienced analyst 18 days on average to process the report without using any AI tools. In the first two to four weeks after the filing, analysts might grapple with the complexity of the report, which leads to an increase in volatility. The informativeness of the report is only realised about six to eight weeks after the filing, resulting in a corresponding reduction in uncertainty. 

Motivated by the idea that investors take time to learn about important corporate attributes, we conducted a comprehensive analysis of the uncertainty dynamics in the ten-week window following 10-K filings. As a measure of uncertainty, we use the implied volatility from option prices. Since option prices are forward-looking, option-implied volatility can be thought of as a measure of the perceived volatility of returns of the underlying stock.

Using this technique, we observed two effects: In the first two to four weeks, there was a 0.4 percent increase in volatility on average, followed by a 2.6 decrease in volatility in the subsequent six weeks. The net effect was a 2.2 percent reduction relative to the volatility level around the filing date.

What is said and how it’s said matter

The type of information that companies convey and how they convey it in the 10-K reports affect volatility. In our study, we used file size as an indicator of complexity, on the basis that the bigger the file size, the more complex the reportis. The level of complexity and resultant volatility could, under certain conditions, override the uncertainty-reduction effect of information.

Through textual analysis, we found that numerical information tends to increase informativeness and decrease complexity, whereas text-based information has the opposite effect. Topic analysis further revealed that topics covered in the “Risk Factors” section mainly capture the complexity of 10-K filings, which increase short-term volatility. On the other hand, topics in the “Managerial Discussion and Analysis” (MD&A) section mainly increase informativeness, which reduce long-term volatility. 

The complexity and informativeness of disclosures as well as the time of their release can affect prices in different ways, in different time periods.

Matter of timing 

The decrease in volatility between the fourth and tenth week after the 10-K filing could be used to investors’ advantage if they factor this volatility pattern in their options strategy. In general, the sharper the decrease in volatility, the higher the profitability of an options strategy that benefits from a decrease in volatility. 

Based on our findings, we observed that volatility tends to be more pronounced for companies with larger 10-K file size, which means they experience a bigger increase in volatility in the first two to four weeks and a sharper decrease in volatility in the subsequent six weeks. These companies with large 10-K file sizes are also typically bigger and tend to be easier to trade. 

To appreciate the magnitude of the effect, take for instance the implementation of short straddle strategies on options between two to four weeks and eight to ten weeks following the 10-K filings. Our data shows that this strategy, which takes advantage of a fall in volatility, can deliver up to 16 percent higher annualised returns when applied to companies with large 10-K report sizes than those with smaller reports.

We also observed a link between uncertainty and the transparency of the company. Specifically, companies with low analyst coverage and low institutional ownership display a stronger relationship between 10-K file size and short-term increase in volatility. This suggests that a less transparent information environment impedes the incorporation of information into asset prices, resulting in investors perceiving higher uncertainty in the short run.

In a nutshell, our study sheds light on how financial markets process information and the role of information on asset prices. It underscores the importance of investor learning, and therefore, the relevance of timing when it comes to understanding the opposing effects of complexity and informativeness on asset prices.