Investors and analysts trying to forecast the volatility of a company’s stock returns can find crucial insights in publicly available corporate disclosures, according to a new study.
Under SEC disclosure requirements, corporate managers report their forecasts of a company’s stock-return volatility over the next few years, as Eccles School professors Atif Ellahie and Xiaoxia Peng note in their paper “Management Forecasts of Volatility.” While these forecasts are meant for valuing stock options given to employees as compensation, Ellahie and Peng found they also accurately predict future fluctuations in stock prices and company earnings.
They credited the accuracy of these predictions to managers’ understandings of a company’s internal operations, opportunities, and challenges.
“Managers seem to be able to combine public information with their internal information to develop high-quality forecasts about the fluctuations in future firm performance,” said Ellahie, a former Executive Director at UBS Investment Bank .
The information — often buried in companies’ annual 10-K reports — could be especially useful for would-be company investors and acquirers, who could use the details to improve their forecasts of future cash flows and returns, the researchers said.
“This information should be helpful for anyone interested in managing risk in their portfolio or seeking risk by trading on volatility in the options market,” said Peng, an expert on executive compensation.