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

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-grad...

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Bibliographic Details
Published in:The Journal of finance (New York) 2015-12, Vol.70 (6), p.2489-2538
Main Authors: ELLUL, ANDREW, JOTIKASTHIRA, CHOTIBHAK, LUNDBLAD, CHRISTIAN T., WANG, YIHUI
Format: Article
Language:English
Subjects:
Assets
Bonds
Capital
Cost accounting
Economic crisis
Economic models
Financial institutions
Flexibility
Historical cost accounting
Incentives
Insurance industry
Market value
Markets
Organizational behavior
Property
Regulation
Securities trading
States
Studies
Trading
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Summary: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.
ISSN:0022-1082
1540-6261
DOI:10.1111/jofi.12357