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Financial Reporting Opacity and Expected Crash Risk: Evidence from Implied Volatility Smirks


  • Accepted by Michael Welker and Steven Salterio. We are especially grateful to Steve Salterio, Michael Welker, and two anonymous reviewers for their many insightful and constructive suggestions. We also thank Paul Brockman, Qiang Cheng, Mo Khan, Franco Wong, Yong Yu, and participants of seminars at the City University of Hong Kong, Fudan University, and Singapore Management University for their helpful comments on earlier versions of the manuscript. All errors are our own. We acknowledge financial support for this research from the Startup Grants of the City University of Hong Kong and the GRF grant of the Hong Kong SAR government (Project No: 144511).


The recent financial crisis has stimulated a renewed interest in understanding the determinants of stock price crash risk (i.e., left tail risk). Recent research shows that opaque financial reports enable managers to hide and accumulate bad news for extended periods. When the accumulated bad news reaches a certain tipping point, it will be suddenly released to the market at once, resulting in an abrupt decline in stock price (i.e., a crash). This study extends this line of research by examining the impact of financial reporting opacity on perceived or expected crash risk. Prominent economists, such as Olivier Blanchard, argue that removing the perception of tail risks (in addition to realized tail risks) is crucial in restoring investor confidence and stabilizing the stock market. Using the steepness of option implied volatility skew as a proxy for perceived crash risk, we find that accrual management, the presence of financial statement restatements, and auditor-attested internal control weakness are all positively and significantly associated with the level of perceived crash risk. Our results suggest that improving financial reporting transparency is an important mechanism for firms and policymakers to reduce the perception of tail risks and stabilize the stock market.