Three essays on transparency, risk and derivative holdings of banks

Abstract

This dissertation consists of three essays on bank transparency, risk and derivative holdings. The first essay empirically investigate the effect of the Capital Purchase Program (CPP) under the Troubled Asset Relief Program on the information quality, or transparency, of participating banks (CPP banks) by examining changes in their loan loss provisions after being approved for government investment. I demonstrate that the CPP banks recognized smaller and less timely loan loss provisions, and they increased the discretionary use of loan loss provisions for earnings and capital management incentives. These findings suggest that the CPP banks reduced the quality of financial statements and transparency more than the non-CPP banks did. The second essay investigate the relation between information transparency and market’s perception of risk especially for bank industry. I find that banks with more transparent information environment are associated with lower systematic or idiosyncratic risk in stock markets, and banks that aggressively engage in discretionary use of loan loss provisions are associated with the lower ratio of systematic to idiosyncratic risk. I further find that these effects of transparency on stock market risks is greater in recessionary period. Our results provide the empirical support for the argument that providing more bank-specific information about the risk of loan portfolios mitigate uncertainty about future events. The third essay examine the impact of derivatives held by U.S. bank holding companies on their market valuations. Using bank-level data with detailed information on the notional amounts of derivative positions according to holding purposes and underlying asset types, I shows that derivative instruments held for hedging rather than trading purposes contribute to enhancing market values, and the positive effects exhibit non-monotonic patterns indicating that excessive amounts of derivatives holdings deteriorate market values. I further find that interest rate derivatives are the main source of high valuations.