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The implication of unrecognized asset value on the relation between market valuation and debt valuation adjustment

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  • Matthew C. Cedergren

    (University of Pennsylvania)

  • Changling Chen

    (University of Waterloo)

  • Kai Chen

    (Wilfrid Laurier University)

Abstract

Under SFAS No. 159, U.S. firms can measure debt liabilities at fair value, which results in recognition of unrealized gains and losses from debt valuation adjustments (DVA) when a firm’s own credit risk changes. Critics have raised concerns about the counterintuitive income consequences of DVA; that is, when a firm’s credit risk increases (i.e., bad news), debt values decrease, and resulting DVA gains increase the firm’s income (i.e., good news), and vice versa. In this paper, we examine the relation between market valuation and DVA gains and losses, conditioning on the level of unrecognized asset value (UAV). We develop a model to demonstrate the mitigating effect of UAV on the relation between equity returns and DVA. We show that, while the association between equity returns and DVA is positive when the level of UAV is low, the association decreases and eventually turns negative with increasing levels of UAV.

Suggested Citation

  • Matthew C. Cedergren & Changling Chen & Kai Chen, 2019. "The implication of unrecognized asset value on the relation between market valuation and debt valuation adjustment," Review of Accounting Studies, Springer, vol. 24(2), pages 426-455, June.
    • Handle: RePEc:spr:reaccs:v:24:y:2019:i:2:d:10.1007_s11142-019-9486-2
    DOI: 10.1007/s11142-019-9486-2
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    Cited by:

    1. Wen Lin & Argyro Panaretou & Grzegorz Pawlina & Catherine Shakespeare, 2023. "What can we learn about credit risk from debt valuation adjustments?," Review of Accounting Studies, Springer, vol. 28(4), pages 2556-2588, December.
    2. Ryan McDonough & Argyro Panaretou & Catherine Shakespeare, 2020. "Fair value accounting: Current practice and perspectives for future research," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 47(3-4), pages 303-332, March.

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    More about this item

    Keywords

    Debt valuation adjustment; Unrecognized asset value; Market valuation; Fair value of liabilities; Balance sheet incompleteness;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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