Loan Loss Provisions and Bank Stock Returns
24 Pages Posted: 8 Apr 2019 Last revised: 24 May 2019
Date Written: January 8, 2019
This paper examines the asset pricing implication of loan loss provisions (LLP). LLP is a bank’s dominant accrual and a key determinant of informativeness of banks’ financial reports. We find banks with low LLP have significantly higher returns than banks with high-LLP. A long-short investment strategy that buys stocks in the lowest LLP portfolio and sells in the highest LLP portfolio earns statistically significant alpha of 97 basis points per month. The predictive power of LLP is prevalent after controlling for size and bank capital. Further analyses suggest the effect of LLP arises because investors do not fully understand information on LLP, which leads to mispricing.
Keywords: Loan Loss Provisions; Banking; Accruals; Return Predictability, Mispricing
JEL Classification: G12, G21
Suggested Citation: Suggested Citation