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Friday, April 17, 2015

The Effects of Accounting Practices on Derivative Based Earnings Volatility

Accounting practices can have a large impact on risk management. Understanding hedging and derivatives volatility is important for corporate investors and banks that want to reduce risks and meet investor expectations.

Because derivatives and hedging can cause calamity for banks, businesses, and societal stakeholders they make a solid subject for research. A study by Dr. Drakopoulou extended prior research on corporate risk management activities of BHCs and may effect social change by presenting new evidence on the effects of SFAS 133 economic hedges on earnings volatility.

Abstract:

The goal of this research was to investigate the controversy surrounding the inability of Statement of Financial Accounting Standard No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities to portray the economics of hedging. This research examined whether or not the possibility of increased volatility evolved from economic hedges that do not qualify for hedge accounting under SFAS 133 prompted Bank Holding Companies (BHCs) to adjust their corporate risk management strategy to one that is more accounting responsive. Based on the results of this research, BHCs' which increased the level of accounting hedges and decreased the level of economic hedges experienced a significant decrease in earnings volatility relative to pre-SFAS 133. The findings suggest that BHCs' ability to reduce earnings volatility and increase earnings smoothing to meet analysts' expectations after the 2008 amendment of SFAS 133 has an adverse impact on BHCs' continual use of economic hedges. Analysts and investors are recommended to evaluate further BHCs' risk strategies to gain a better representation of their risk paradigm with derivatives. This study extends prior research on corporate risk management activities of BHCs and contributes to social change by presenting new affirmation to investors of the influence of SFAS 133 economic hedges on earnings volatility.

You may download the full paper HERE.

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