The link between the share of banks’ Level 3 assets and their default risk and default costs

Ulf Mohrmann () and Jan Riepe ()
Additional contact information
Ulf Mohrmann: University of Konstanz
Jan Riepe: University of Tuebingen

Review of Quantitative Finance and Accounting, 2019, vol. 52, issue 4, No 10, 1163-1189

Abstract: Abstract We empirically explore the risk relevance of Level 3 fair value estimates. Thereby we focus on banks’ default risk as well as banks’ default costs. Both variables are especially important to banks’ creditors and the regulatory authorities that rely on the information in financial statements. In a fixed-effects panel model, we find an association between banks’ share of Level 3 estimates and higher volatilities as well as lower market values. Both factors add up to much higher default risks in bank-quarters with a larger share of Level 3 estimates. The association remains strong even after controlling for the systematic information risk in Level 3 estimates. Furthermore, we find a strong association between the share of Level 3 estimates and banks’ default costs in transactions with low information risk. Combining the different pieces of evidence, our results show the presence of two underlying estimation errors in Level 3 assets: information risk and overvaluation. Our results point towards the benefits of complementing the information in financial statements with capital market information for bank creditors and bank regulators.

Keywords: Banking; Bank default; Fair value accounting; Level 3 assets (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 M41 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://link.springer.com/10.1007/s11156-018-0740-7 Abstract (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:rqfnac:v:52:y:2019:i:4:d:10.1007_s11156-018-0740-7

Ordering information: This journal article can be ordered from
http://www.springer.com/finance/journal/11156/PS2

DOI: 10.1007/s11156-018-0740-7

Access Statistics for this article

Review of Quantitative Finance and Accounting is currently edited by Cheng-Few Lee

More articles in Review of Quantitative Finance and Accounting from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().