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

• DOI: 10.1111/jofi.12357
• Publication Date: 2015-09-04T09:46:41Z
• Authors: ANDREW ELLUL; CHOTIBHAK JOTIKAS...; CHRISTIAN T. LUND...; YIHUI WANG
• Keywords: Value (mathematics); Life insurance

ABSTRACT 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 hold speculative‐grade assets at historical cost, the degree which recognize market values differs across U.S. states. During crisis, facing lesser of value recognition are less likely sell downgraded asset‐backed securities. To improve positions, disproportionately resort gains trading, selectively selling otherwise unrelated bonds high unrealized gains, transmitting shocks markets.