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http://ssrn.com/abstract=1972027
 
 

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Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading


Andrew Ellul


Indiana University - Kelley School of Business - Department of Finance

Chotibhak Jotikasthira


University of North Carolina Kenan-Flagler Business School

Christian T. Lundblad


University of North Carolina Kenan-Flagler Business School

Yihui Wang


Fordham University

February 18, 2015

Journal of Finance, Forthcoming

Abstract:     
We provide evidence concerning the use of historical cost (HCA) versus mark-to-market (MTM) accounting in regulating financial institutions. Accounting rules, through their interactions with capital regulations, alter financial institutions’ trading behavior. The insurance industry provides a laboratory to explore these interactions: life insurers have greater flexibility to hold speculative-grade assets at HCA than P&C insurers, and the degree to which life insurers recognize market values differs across U.S. states. During the financial crisis, we show that insurers facing HCA are less likely to sell significantly downgraded asset-backed securities than those facing MTM. To improve their capital positions, the insurers facing HCA disproportionately resort to gains trading, selectively selling otherwise unrelated bonds with the highest unrealized gains, thereby transmitting shocks across markets.

Number of Pages in PDF File: 108

Keywords: Regulation, Mark to market, Historical cost accounting, Gains trading, Fire sales, Asset-backed securities (ABS), Corporate bonds, Insurance companies

JEL Classification: G11, G12, G14, G18, G22


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Date posted: December 14, 2011 ; Last revised: April 15, 2015

Suggested Citation

Ellul, Andrew and Jotikasthira, Chotibhak and Lundblad, Christian T. and Wang, Yihui, Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading (February 18, 2015). Journal of Finance, Forthcoming. Available at SSRN: http://ssrn.com/abstract=1972027 or http://dx.doi.org/10.2139/ssrn.1972027

Contact Information

Andrew Ellul
Indiana University - Kelley School of Business - Department of Finance ( email )
1309 E. 10th St.
Bloomington, IN 47405
United States

Chotibhak Jotikasthira (Contact Author)
University of North Carolina Kenan-Flagler Business School ( email )
Chapel Hill, NC 27599-3490
United States

Christian T. Lundblad
University of North Carolina Kenan-Flagler Business School ( email )
Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-8441 (Phone)

Yihui Wang
Fordham University ( email )
33 West 60th Street
New York, NY 10023
United States
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