Financial Risk Disclosure Return Premium: A Topic Modeling Approach

We examine the risk factors disclosed in the 10-K financial statement section 1A across 9 years with over 500 hundred companies. We propose a financial disclosure risk factor to extend the Fama-French 3 factor model and Fama-MacBeth cross-section regression. Using the risk factors data from 2015 to 2023, we find the average risk-return premium across nine sectors is significant after controlling for other risk factors from the Fama-French 3-factor model. The premium is measured by monthly return series on risky-minus-less risky stocks or by the coefficient of stock risk factor estimated from cross-section Fama-MacBeth regressions. These text risk factors can potentially be used to construct portfolios that can generate significant returns across different sectors.