Banks' Discretion over the Debt Valuation Adjustment for Own Credit Risk

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Serval ID
serval:BIB_7441A64C0CB8
Type
Report: a report published by a school or other institution, usually numbered within a series.
Publication sub-type
Working paper: Working papers contain results presented by the author. Working papers aim to stimulate discussions between scientists with interested parties, they can also be the basis to publish articles in specialized journals
Collection
Publications
Institution
Title
Banks' Discretion over the Debt Valuation Adjustment for Own Credit Risk
Author(s)
Dong M., Doukakis L.C., Ryan S.G.
Institution details
SSRN
Issued date
2016
Language
english
Abstract
Banks that recognize financial liabilities at fair value currently must record unrealized gains (losses) on these liabilities attributable to increases (decreases) in the banks’ own credit risk, referred to as the debt (or debit) valuation adjustment (DVA), in earnings each period. For a sample of publicly traded European banks during 2008-2013, we investigate the economic and discretionary determinants of DVA. We find that DVA exhibits the expected associations with economic factors, being positively associated with the change in banks’ bond yield spread and negatively associated with the changes in banks’ unsecured debt and average remaining bond maturity. We also provide evidence that banks exercised discretion over DVA to smooth earnings during the recent financial crisis and its immediate aftermath. To remove non-discretionary smoothing of earnings, we decompose DVA into nondiscretionary (normal) and discretionary (abnormal) components and find that abnormal DVA is negatively associated with pre-managed earnings, controlling for banks’ abnormal loan loss provisions (LLP) and realized securities gains and losses (RGL), consistent with banks exercising discretion over DVA to smooth earnings. We further find that banks that record larger LLP and that have histories of using LLP to smooth earnings use DVA less to smooth earnings, consistent with LLP and DVA being substitutable ways to smooth earnings. These findings have implications for how bank regulators and investors should interpret banks’ reported DVA. They may support the FASB’s recent decision in ASU 2016-1 to require firms to record DVA in other comprehensive income.
Keywords
Debt valuation adjustment, DVA, Own credit risk, Fair value option for liabilities, Income smoothing
Create date
06/09/2016 8:55
Last modification date
21/08/2019 5:13
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