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Mixing fair-value and historical-cost accounting: predictable other-comprehensive-income and mispricing of bank stocks

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  • Peter Easton

    (University of Notre Dame)

  • Xiao-Jun Zhang

    (University of California, Berkeley)

Abstract

Other comprehensive income (OCI) items are often considered to be transitory (Chambers et al. 2007; IASB 2013; CFA2014). In this paper, we show that a significant portion of OCI, namely unrealized gains and losses (UGL) from available-for-sale (AFS) debt securities, is non-transitory: a negative correlation between accumulated unrealized gains and losses in the current period and next period UGL is predicted, and we show that this correlation is economically and statistically significant. This correlation is due to a mix of accounting methods of measurement of income from fixed-income securities: UGL are recognized based on fair values, whereas interest income is measured based on historical cost. We document that (1) this negative correlation helps explain a previously unexplained negative correlation in other comprehensive income (OCI), and (2) investors seem to price total UGL disregarding (or not understanding) the predictable, accounting-driven component of UGL.

Suggested Citation

  • Peter Easton & Xiao-Jun Zhang, 2017. "Mixing fair-value and historical-cost accounting: predictable other-comprehensive-income and mispricing of bank stocks," Review of Accounting Studies, Springer, vol. 22(4), pages 1732-1760, December.
    • Handle: RePEc:spr:reaccs:v:22:y:2017:i:4:d:10.1007_s11142-017-9423-1
    DOI: 10.1007/s11142-017-9423-1
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    References listed on IDEAS

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    3. Kathryn E. Easterday & Pradyot K. Sen, 2023. "Another look at the dividend-price relationship in the accounting valuation framework," Review of Quantitative Finance and Accounting, Springer, vol. 61(3), pages 879-925, October.

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