Effects of SFAS 133 on the Risk Relevance of Accounting Measures of Banks’ Derivative Exposures

Abstract

We provide evidence on the effects of SFAS 133 on the risk relevance of accounting measures of bank derivative exposures to bond markets. First, we find that interest rate derivatives classified as hedging are more negatively associated with fixed-rate bond spreads after SFAS 133. We also find that hedging derivatives offset non-trading positions to a greater extent after SFAS 133. Second, for the largest 25 banks, we find that interest and foreign exchange rate trading derivatives are more negatively associated with fixed-rate bond spreads after SFAS 133, consistent with more economic hedges being classified as trading after SFAS 133. For these banks, trading derivative exposures offset non-derivative trading exposures to a greater extent after SFAS 133. Our results suggest that, contrary to critics’ claims, SFAS 133 has increased the risk relevance of accounting measures of derivative exposures to bond investors and benefited banks in terms of reducing their cost of capital.

Voluntary risk management committee formation: Determinants and short-term outcomes

“…Additionally, theory developed by Smith and Stulz (1985) suggests that risk management can increase the expected value of the firm by decreasing the likelihood of financial distress. Ahmed et al (2006Ahmed et al ( , 2011 indicate that financial institutions hold derivatives for trading on their own account (trading purposes) and to manage risk (hedging purposes). Such holdings can be comprised of customerrelated positions (i.e., positions that can increase or reduce risk), speculative positions (i.e., positions that increase risk), and economic hedges (i.e., positions that decrease risk) (Ahmed et al, 2011).…”

“…Ahmed et al (2006Ahmed et al ( , 2011 indicate that financial institutions hold derivatives for trading on their own account (trading purposes) and to manage risk (hedging purposes). Such holdings can be comprised of customerrelated positions (i.e., positions that can increase or reduce risk), speculative positions (i.e., positions that increase risk), and economic hedges (i.e., positions that decrease risk) (Ahmed et al, 2011). Given the importance of derivatives as a tool to manage exposures to macroeconomic risk factors such as interest rate risk and foreign exchange rate risk, we expect that effective RMCs would have an impact on the extent of such positions (hedging and speculative).…”

Improving Financial Statement Footnotes: Evidence from Derivative and Hedging Disclosures

“…Similarly, Ahmed et al (2011) investigate the effects of SFAS 133 and find that the standard reduced banks' cost of capital and resulted in more risk-relevant derivative information for banks' bond investors. Venkatachalam (1996) provides evidence about derivatives' value-relevance by documenting an association between SFAS 119 derivative fair value disclosures and banks' share prices.…”

Growth in financial derivatives: The public policy and accounting incentives

“…One such a study is Ahmed et al (2011), which offers a negative association between the use of derivatives and fixed-rate bond spreads as evidence of risk reduction arising from applying FAS 133. However, Keffala et al (2012) find that using different financial derivative instruments impacts total equity risk (standard deviation of return) differently; equity risk decreases with the use of forward contracts but increases with the use of options.…”