Do Financial Regulations Shape the Functioning of Financial Institutions’ Risk Management in ABS Investment?

Review of Financial Studies, Forthcoming

61 Pages Posted: 24 Jul 2017 Last revised: 14 Nov 2019

See all articles by Xuanjuan Chen

Xuanjuan Chen

Shanghai University of Finance and Economics

Eric James Higgins

Kansas State University - College of Business Administration

Han Xia

University of Texas at Dallas - Naveen Jindal School of Management

Hong Zou

The University of Hong Kong - Faculty of Business and Economics

Date Written: March 12, 2019

Abstract

We show that installing stronger risk management into financial institutions – a proposal widely discussed following the 2008 financial crisis – is insufficient to constrain institutions’ exposure to investment with lurking risk, such as asset-backed securities. Financial regulations affect the functioning of risk management: risk management constrains institutions’ exposure to risky ABS when they face mark-to-market reporting combined with capital requirements; however, this role is considerably weaker when capital requirements are combined with historical-cost-accounting. We find suggestive evidence that financial regulations affect risk management functions through promoting risk managers’ efforts in uncovering ABS risk and curbing executives’ incentives to take excessive risk.

Keywords: financial institutions; asset-backed securities; risk management; financial regulations

JEL Classification: G11, G22, G28, G32

Suggested Citation

Chen, Xuanjuan and Higgins, Eric James and Xia, Han and Zou, Hong, Do Financial Regulations Shape the Functioning of Financial Institutions’ Risk Management in ABS Investment? (March 12, 2019). Review of Financial Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3005438 or http://dx.doi.org/10.2139/ssrn.3005438

Xuanjuan Chen

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

Eric James Higgins

Kansas State University - College of Business Administration ( email )

117 D Calvin Hall
Manhattan, KS 66506
United States
(785)-532-3936 (Phone)

Han Xia

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

Hong Zou (Contact Author)

The University of Hong Kong - Faculty of Business and Economics ( email )

Hong Kong

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