THE ROLE OF DERIVATIVES IN THE FINANCIAL CRISIS AND THEIR IMPACT ON SECURITY PRICES

Ronald A. Stunda

Accounting & Taxation, 2014, vol. 6, issue 1, 39-50

Abstract: This study takes on two divergent notions concerning derivatives; that they are dangerous instruments (Warren Buffet) versus the concept that they help to reduce risk (Allen Greenspan). These notions are assessed from the perspective of the recent Financial Crisis in which derivatives were assigned a good deal of the blame for the meltdown. This study analyzes three different study periods; Pre-Crisis (2003, 2004, 2005), Crisis (2008, 2009, 2010), and Post-Crisis (2011, 2012, 2013-1st quarter). In addition, the study also analyzes three different groups of firms containing 100 firms each; firms engaging in the use of derivatives and accepting TARP funds, firms engaging in derivatives and not accepting TARP funds, and firms not engaging in derivatives and not accepting TARP funds. Results indicate that for Crisis and Post-Crisis periods, investors tend to discount accounting earnings releases in making investment decisions. For the firms using derivative and not accepting TARP funds and firms not using derivatives and not accepting TARP funds, the results across all three study periods are almost identical, accounting earnings reflect positive information-enhancing signals on security prices. This does not mean that security prices continued a steady upward trek, but only that investors placed a greater positive reliance on earnings in making investment decisions, in other words, they tended to not discount earnings releases.

Keywords: Derivatives; Security Prices; TARP (search for similar items in EconPapers)
JEL-codes: G3 M41 N2 (search for similar items in EconPapers)
Date: 2014
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