What can we learn about credit risk from debt valuation adjustments?

Wen Lin, Argyro Panaretou (), Grzegorz Pawlina and Catherine Shakespeare
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Wen Lin: Central University of Finance and Economics
Argyro Panaretou: Lancaster University
Grzegorz Pawlina: Lancaster University
Catherine Shakespeare: University of Michigan

Review of Accounting Studies, 2023, vol. 28, issue 4, No 19, 2556-2588

Abstract: Abstract Motivated by the debate about the introduction of the fair value option for (financial) liabilities (FVOL) and the requirement to recognize and separately disclose in financial statements debt valuation adjustments (DVAs), this study explores what we can learn about a firm’s credit risk from DVAs. Using a sample of US bank holding companies that elect the FVOL, we show that DVAs generally cannot be explained by the same factors that explain contemporaneous changes in bank’s credit quality. We further find that DVAs can explain future changes in credit risk when the fair value of liabilities is based on managerial inputs (Level 3). Overall our results suggest that managers have an information advantage in estimating credit risk and that DVAs provide inside information to the market.

Keywords: Financial liabilities; Fair value option; Debt valuation adjustments; Credit risk (search for similar items in EconPapers)
JEL-codes: G12 G21 M41 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/s11142-022-09705-0

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