The Impact of Risk Modeling on the Market Perception of Banks’ Estimated Fair Value Gains and Losses for Financial Instruments
51 Pages Posted: 21 Apr 2015
Date Written: April 2015
We examine whether and how measures of market and credit risk modeling identified from banks’ financial reports enhance the returns-relevance of their estimated annual unrealized fair value gains and losses for financial instruments. To capture differences in market liquidity and fair valuation difficulties across types of financial instruments, we distinguish unrealized gains and losses that are recorded in net income versus recorded in other comprehensive income versus calculable using financial statement note disclosures. We predict and generally find that banks’ market (credit) risk modeling enhances the returns-relevance of their unrealized fair value gains and losses, more so for less liquid instruments subject to greater market-risk-related (credit-risk-related) valuation difficulties and during periods for which market (credit) risk is higher. We obtain these findings both for banks’ unadjusted risk modeling measures and for the portions of these measures that we model as attributable to banks’ risk modeling activities, but not for the portions we model as attributable to banks’ disclosure of these activities.
Keywords: Risk modeling, market risk, credit risk, chief risk officer, fair value, estimates disclosure.
JEL Classification: G14, G21, G32, M41
Suggested Citation: Suggested Citation