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

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  • ANDREW ELLUL
  • CHOTIBHAK JOTIKASTHIRA
  • CHRISTIAN T. LUNDBLAD
  • YIHUI WANG

Abstract

Accounting rules, through their interactions with capital regulations, affect financial institutions’ trading behavior. The insurance industry provides a laboratory to explore these interactions: life insurers have greater flexibility than property and casualty insurers to hold speculative‐grade assets at historical cost, and the degree to which life insurers recognize market values differs across U.S. states. During the financial crisis, insurers facing a lesser degree of market value recognition are less likely to sell downgraded asset‐backed securities. To improve their capital positions, these insurers disproportionately resort to gains trading, selectively selling otherwise unrelated bonds with high unrealized gains, transmitting shocks across markets.

Suggested Citation

  • Andrew Ellul & Chotibhak Jotikasthira & Christian T. Lundblad & Yihui Wang, 2015. "Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading," Journal of Finance, American Finance Association, vol. 70(6), pages 2489-2538, December.
  • Handle: RePEc:bla:jfinan:v:70:y:2015:i:6:p:2489-2538
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    File URL: https://doi.org/10.1111/jofi.12357
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    Cited by:

    1. Timmer, Yannick, 2017. "Cyclical Investment Behaviour across Financial Institutions," ECMI Papers 12747, Centre for European Policy Studies.
    2. Palea, Vera, 2019. "Accounting for Sustainable Finance: Does Fair value Accounting Fit for Long-term Investing in Equity?," Department of Economics and Statistics Cognetti de Martiis. Working Papers 201912, University of Turin.
    3. Lu, Erin P. & Lai, Gene C. & Ma, Qingzhong, 2017. "Organizational structure, risk-based capital requirements, and the sales of downgraded bonds," Journal of Banking & Finance, Elsevier, vol. 74(C), pages 51-68.
    4. repec:oup:rfinst:v:31:y:2018:i:8:p:2983-3018. is not listed on IDEAS
    5. Amiraslani, Hami & Lins, Karl & Servaes, Henri & Tamayo, Ane, 2017. "A Matter of Trust? The Bond Market Benefits of Corporate Social Capital during the Financial Crisis," CEPR Discussion Papers 12321, C.E.P.R. Discussion Papers.
    6. Laura Blattner & Luisa Farinha & Francisca Rebelo, 2017. "When Losses Turn Into Loans: The Cost of Undercapitalized Banks," 2017 Papers pbl215, Job Market Papers.
    7. repec:aea:aecrev:v:108:y:2018:i:8:p:2246-76 is not listed on IDEAS
    8. Guillaume Plantin & Jean Tirole, 2018. "Marking to Market versus Taking to Market," American Economic Review, American Economic Association, vol. 108(8), pages 2246-2276, August.
    9. Chotibhak, Jotikasthira & Ellul, Andrew & Kartasheva, Anastasia & Lundblad, Christian & Wagner, Wolf, 2018. "Insurers as Asset Managers and Systemic Risk," CEPR Discussion Papers 12849, C.E.P.R. Discussion Papers.
    10. Efing, Matthias, 2015. "Arbitraging the Basel securitization framework: Evidence from German ABS investment," Discussion Papers 40/2015, Deutsche Bundesbank.
    11. Ralph S.J. Koijen & Motohiro Yogo, 2017. "Risk of Life Insurers: Recent Trends and Transmission Mechanisms," NBER Working Papers 23365, National Bureau of Economic Research, Inc.
    12. repec:eee:jfinec:v:130:y:2018:i:2:p:308-326 is not listed on IDEAS
    13. Timmer, Yannick, 2018. "Cyclical investment behavior across financial institutions," ESRB Working Paper Series 77, European Systemic Risk Board.
    14. Laux, Christian, 2016. "The economic consequences of extending the use of fair value accounting in regulatory capital calculations: A discussion," Journal of Accounting and Economics, Elsevier, vol. 62(2), pages 204-208.
    15. Divya Kirti, 2017. "When Gambling for Resurrection is Too Risky," IMF Working Papers 17/180, International Monetary Fund.
    16. Li, Jing, 2017. "Accounting for banks, capital regulation and risk-taking," Journal of Banking & Finance, Elsevier, vol. 74(C), pages 102-121.
    17. Möhlmann, Axel, 2017. "Interest rate risk of life insurers: Evidence from accounting data," Discussion Papers 10/2017, Deutsche Bundesbank.
    18. repec:eee:jaecon:v:66:y:2018:i:1:p:25-45 is not listed on IDEAS
    19. repec:eee:jfinec:v:129:y:2018:i:2:p:268-286 is not listed on IDEAS
    20. repec:eee:moneco:v:95:y:2018:i:c:p:1-17 is not listed on IDEAS
    21. Girardi, Giulio & Hanley, Kathleen Weiss & Nikolova, Stanislava & Pelizzon, Loriana & Getmansky, Mila, 2018. "Portfolio similarity and asset liquidation in the insurance industry," SAFE Working Paper Series 224, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.

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