Research On The Determinants And Effects Of Scenario-based Risk Analysis For Securities Analysts

The world today is undergoing major changes unseen in a century with unprecedented uncertainties.Turbulences in both domestic and international financial system have resulted in tremendous financial exposure.The 20^th National Congress of the Communist Party stressed“Deepen structural reform in the financial sector,strengthen and refine modern financial regulation,and ensure no systemic risks arise”.Risk is an important component for security valuation.Due to information asymmetry,the potential risks hidden in security assets are often ignored or misjudged by investors,which leads to the decoupling of asset prices from the inherent risks and induces financial bubbles.Therefore,how to fully analyze and evaluate risks and incorporate them into security valuation process is a major,urgent question we must tackle.The answers will help effectively forestall financial risks,improve the efficiency of security pricing,protect the rights and interests of retailing investors,and further promote the stability of the financial market development.Due to the complexity and expertise required to understand risk information,ordinary investors may not fully comprehend the risks involved in a company’s operations.As intermediaries of market information,securities analysts possess professional knowledge and have access to advantageous information channels to evaluate risks.If they can scientifically assess company risks in their research reports,it will greatly improve the pricing efficiency of securities and prevent market risks.However,the policymakers in China do not explicitly require security analysts to assess risks.Do analysts conduct risk assessments of underlying firms and incorporate adequate risk considerations into target price forecasts in practice?What motivates analysts to be more willing to conduct a comprehensive and in-depth risk assessment?Does a risk assessment approach have significant effects on the quality of analyst forecasts,and further improve the efficiency of investor decision-making and market pricing?Since analyst forecast process is a"black box"and domestic analysts do not place much emphasis on risk assessment and risk information disclosure.there is a scarcity of data on risk forecasts of domestic analysts.Therefore,few studies in China examine such issues,and it is difficult to find answers from local Chinese research reports.Scenario-based risk analysis is a method that uses scenario analysis to evaluate the prospective risk situation of a target object in a multidimensional manner.It constructs multiple possible scenarios to evaluate risks and returns under different conditions and has become a mature risk assessment method internationally.Currenty,international investment banks have gradually introduced scenario-based risk assessment into the valuation of securities analysts and have advocated for their analysts to adopt this method effectively for risk assessment and risk information disclosure,albeit not mandatorily.It encourages analysts to fully consider the uncertain factors that affect the future value of a company,predict the best-,base-,and worst-case scenarios for the company,conduct in-depth analysis of the paths through which these uncertainties affect the firm value in different scenarios,as well as the probabilities of each scenario,and demonstrate the entire process by which investors weigh risks and returns.With the rapid development of China’s economy,research reports by international investment bank analysts on Chinese listed companies have gradually increased.Some of these reports use scenario-based risk analysis,which provide an excellent opportunity to study the determinants and effects of analysts’use of scenario-based risk analysis in the context of Chinese companies.Using 143,222 analyst research reports from top 10 international investment banks for Chinese listed companies（including domestic and overseas listed firms）during 1997-2022,we construct quantitative indicators for scenario-based risk analysis with textual analysis.We examine the determinants of analyst scenario-based risk analysis and its consequences on analyst forecast quality and market reactions.Firstly,this thesis explores the driving factors for analysts to conduct scenario-based risk analysis from the perspectives of information demand and supply.（1）The research on information demand shows that the higher the uncertainty of company value,the more scenario-based risk analysis with respect to firm-specific information（financial,operational,and strategic）that analysts conduct;the higher the macro uncertainty,the more scenario-based risk analysis with respect to macro information that analysts conduct.This indicates that investors’demand for risk information is an important factor that drives analysts to use scenario-based risk analysis.（2）The research on information supply shows that female analysts,team analysts,and analysts from large brokerage firms are more likely to conduct scenario-based risk analysis.This indicates that the analysts who are more sensitive to risks and have better resources are more likely to use scenario-based risk analysis.Furthermore,this thesis examines whether the use of scenario-based risk analysis can improve the quality of analyst target price forecasts.We find that scenario-based risk analysis is significantly positively correlated with analyst forecast accuracy in target prices.The reports with more scenario-based risk analysis,especially with respect to firm-specific information,are more accurate in target price forecasts.These results indicate that analysts can indeed incorporate risk information into securities valuation through scenario-based risk analysis.Heterogeneity analysis shows that the aforementioned effect of scenario-based risk analysis is more pronounced when macro and micro uncertainty is higher,and also for female,team analysts and those affiliated with large brokerages.This indicates that investors’demand for risk information can effectively improve the efficiency of analysts using risk assessment methods,and analysts’sensitivity and resources can effectively enhance the impact of their risk assessment methods on forecast quality.Finally,this paper also finds that scenario-based risk analysis can help improve the quality of analyst earnings forecasts.Finally,this thesis examines whether the use of scenario-based risk analysis can improve the market reaction to analyst target price forecasts.We find that the market reacts more strongly to target price forecasts with scenario-based risk analysis,whether it is specific to firm-specific information or industry and macro information.These results suggest that analysts can indeed convey more valuable information to investors through scenario-based risk analysis.Heterogeneity analysis shows that the market effect of scenario-based risk analysis is more pronounced when macro and micro uncertainty is higher,and also for team,experienced analysts and those affiliated with large brokerages.This indicates that investors’demand for risk information makes scenario-based risk analysis more valuable,and analysts’resources and experience can enhance the market recognition of using scenario-based risk analysis and improve the market reaction to target price forecasts.In sum,the findings of this thesis indicate that the scenario-based approach facilitates analysts assess firm value risk forward-lookingly,comprehensively and prudently,and thereby improves the quality of target price forecasts and the efficiency of investment decision and asset pricing.This thesis comprehensively explores the determinants and effects of analysts using scenario-based risk analysis,making at least four contributions.Firstly,from the perspective of information demand and supply in the determinant tests,we find that the higher the uncertainty and the more efficient the risk information processing,the more likely analysts to conduct scenario-based risk analysis.These effectively reveals the driving mechanism behind analysts`use of scenario-based risk analysis.While a few studies examine the effect of valuation methods and risk discussions in the analyst research process,no literature explores the reasons why analysts use a particular risk assessment method.This article partially reveals its intrinsic motivations from the perspective of information demand and supply,thereby supplementing the literature in this field.Secondly,this thesis thoroughly examines the effects of analysts using scenario-based risk analysis and find that it improves the quality and market reactions of analyst target price forecasts.This indicates that the use of scenario-based risk analysis is helpful for analysts better incorporating potential risks into security prices and improving the pricing efficiency of the capital market.Although existing literature finds that the use of scientific valuation methods is beneficial for analysts to improve their forecast quality,no literature explores whether the use of risk assessment methods is useful for their forecast quality and information contents.This thesis largely expands the related literature.In addition,this thesis further explores the impact of different factors on the effect of scenario-based risk analysis from multiple dimensions such as evaluation contents,language features,company characteristics,macro features,and analyst characteristics,which is helpful for a comprehensive understanding of the important role and mechanism of risk assessment methods in the analyst valuation process and information dissemination.Thirdly,using textual analysis,this thesis develops a qualitative index of scenario-based risk analysis to quantify the the nature of analyst risk assessment,which expands the relevant literature on analyst risk assessment and qualitative risk analysis.Existing studies mainly explore the effects of analyst risk assessment based on quantitative risk indicators.However,due to the complexity and diversity of risks,quantitative risk indicators are difficult to fully reflect the underlying contents of risks.The textual risk information in scenario-based risk analysis can better reveal the main factors affecting the future value of companies and their impact paths under different scenarios.It can better reflect the risk status of the target company and the entire process of analysts trading off risks and returns.Thus,this thesis constructs a dictionary of scenario-based risk analysis to capture the degree to which analysts conduct risk assessment and its evaluation contents and language features,which provides a novel measure of analyst risk assessment for future research.Finally,the conclusions of this thesis have important practical value.Currently,the quality of target price forecasts by securities analysts in China is generally low.Chinese securities regulatory authorities have not issued explicit regulations requiring securities analysts to undertake the responsibilities of risk assessment.Domestic analysts have also not yet adopted standardized risk analysis paradigms in their research.Our findings suggest that the application of scenario-based risk analysis methods is conducive to improving the quality of analyst forecasts in target prices,and that the market responds positively to it.This suggests that introducing a scientific risk assessment method into analyst research is beneficial for the quality and information value of their forecasts,promoting the market pricing of risks,helping investors make rational decisions,and more effectively preventing financial risks.