Economic consequences and financial statement effects of SFAS No. 133 in bank holding companies

This thesis investigates the effects of SFAS No. 133 on bank holding companies (BHCs). Banks argued that SFAS 133 would increase earnings volatility and the cost of preparing financial statements, thereby discouraging firms' usage of derivatives for hedging. To assess banks' argument, this study examines stock price reactions around the major events that increase or decrease the likelihood of promulgating new accounting standards for derivatives and financial statement effects of SFAS 133 after the adoption of SFAS 133.; There were negative stock price reactions in the top 30 BHCs around the date that the FASB announced its plan for new accounting standards for derivatives and the date that the Exposure Draft was released. Further tests reveal that the negative stock price reactions increase with trading of derivatives, usage of derivatives, both trading and usage of derivatives, and usage of options.; I examine three income-affecting sources arising from SFAS 133 (ineffective hedge gains/losses, gains/losses excluded in hedge assessment, effects from cancelled forecasted transactions previously designated as cash flow hedges) to test the impact of SFAS 133 on earnings volatility. Six BHCs in the top 30 BHCs reported more than {dollar}0.01 per share of the three income-affecting portions (TIPs) in absolute value. Further investigation reveals that most of their TIPs come from hedges of mortgage-related assets including mortgage servicing rights. TIPs in the top 30 BHCs did not increase earnings volatility and did not deteriorate analysts' forecast performance. In addition, unrealized gains or losses from cash flow hedges did not increase equity volatility significantly. Three reasons may explain these findings.; First, an additional source of earnings effects whose data are not available (i.e. changes in the fair value of derivatives used for hedging but not designated as hedge accounting) might have affected earnings volatility. Second, some BHCs had already adjusted their hedging strategies in anticipation of an increase of earnings volatility before they adopted SFAS 133. Third, BHCs overemphasized the impact of SFAS 133 on earnings volatility in an effort to attenuate the establishment of SFAS 133 when the impact was unpredictable ex ante.